Foreign Exchange Market

Meaning

The foreign exchange market (forex) is a global decentralized market for the trading of currencies. The main participants in this market are the larger international banks. Financial centres around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.

The spot foreign exchange (forex) market is the world's largest market, with over US$1 trillion traded per day. One derivative of this market is the forex futures market, which is only one one-hundredth the size. 

Hedging and Speculating

Hedging and speculating are the two primary ways in which forex derivatives are used. Hedgers use forex futures to reduce or eliminate risk by insulating themselves against any future price movements. Speculators, on the other hand, want to incur risk in order to make a profit.

All foreign exchange transaction made in India is being regulated either by RBI (Reserve Bank of India) or FEDAI (Foreign Exchange Dealers Association of India).

There are two types of Market

Inter bank / Wholesale Market: One bank deals with another bank. Exchange rate of inter- bank market is known as Inter- Bank Rate. Only banks can deals at interbank rate.

Retail Market: Bank deals with Customer.  Exchange rate of retail market is known as Merchant Rate. Customers can buy or sell currency only at merchant rate.

Bid rate and Ask Rate:

Bid rate is the rate at which bank buys left hand currency.

Ask Rate is the rate at which bank sells left hand currency.

Let’s have an Example

£1= $1.50/1.55

So, $1.50 is bid rate which is called buying rate.

$1.55 is ask rate which is called selling rate.

    We have to know that Bid rate is always smaller than Ask rate.

           

Advantages of Forex markets:

1. Minimal or no commissions - There are no clearing fees, no exchange fees, no government fees and no brokerage fees. 

2. Easy access – if you compare the money you need on the market in comparison with the amount needed for entering the stock, options or futures market, it’s a huge difference. The amount of capital is very low and it allows numerous types of people to easily enter the foreign exchange market. 

3. No middlemen – spot currency trading is decentralized and eliminates middlemen, allowing you to trade directly. 

4. Time and location flexibility – the market is open 24 hours each day, so you don’t have to match your schedule with the one of the market. It doesn’t require a full-time engagement and you can choose the hours that suit your best. Also, you can operate from any corner of the world, as long as you have an Internet connection.

5. Low transaction costs – the transaction cost, determined by the bid/ask spread, is usually less than 0.1%, and it can go even lower in the case of large dealers. 

6. A high liquidity market – the market is huge, so is extremely liquid. Around 1 trillion dollars are exchanged every day, according to the latest figures released by the Bank of International Settlements (BIS). That becomes an advantage, as you don’t have to struggle so much until you will find someone who wants to buy your currency or sell you one. You can’t get stuck and, by using features like stop lose, you will close your position automatically, while not even being in front of the computer. 

7. Leverage – with a little investment you can move large amounts of money. Leverage gives the trader the ability to make nice profits and keep risk capital to a minimum. 

8. No forced deadlines – no one and no rule is forcing you to close a position. You can stay open as long as you consider necessary. 

9. No fixed lot size requirements – your contract size it’s your decision and you are the only one who determines your own lot. 

10. Transparency - due to multi-day market movement, its size and the high number of participants, it is virtually impossible to market manipulation. 

Disadvantages of Forex Markets

1. Differences between retail and wholesale pricing – around two-thirds of the trades are made between dealers and large organizations such as hedge funds and banks. They trade at wholesale prices, while the investor trades at a retail price. Like this it can become a challenge to compete against bigger organization that start with a lower entry point and sell more profitably.

2. Risk of choosing an inexperienced broker – you can find on the internet many people who are targeting fraud so be careful when choosing the broker. 

3. Where there is a winner, there is also a looser – don’t expect necessarily to win lots of money. Remember that for someone to get rich, another has to lose money on the Forex market. 

4. Requires knowledge and time – Without completely knowing the market’s rules and without having patience, your investment might very well soon vanish. 

When you enter Forex market, you have to be fully aware of its advantages, but also disadvantages. Don’t count only on the benefits of this investment to think that you will succeed. Study, practice, improve your skills, keep an eye on all the news and factors that influence the market, and always stick to your established system.

This artice has been shared by Keshav Kumar. He can be reached at Keshabkc6@gmail.com