The Foreign exchange market deals with the trading of different foreign currencies. One currency is traded for another in the foreign exchange market only. Presently the market is by far the largest financial market in the world.
The trade in a foreign exchange market includes trading of different currencies between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Individuals constitute a very small fraction of this market and they participate only through brokers or banks and most of the times they are subject to forex scams.
The foreign exchange market is unique because of many factors such as its trading volumes, its geographical dispersion and the extreme liquidity of the market. Beside that the large number and variety of traders in the market and its long trading hours that is round the clock operation throughout the week except on weekends make it unique.
The average daily turnover in traditional markets is estimated to be over $3 trillion. This is more than ten times the size of the combined daily turnover on all the world's equity markets. Foreign exchange trade has more than doubled since 2001; this is largely due to the growing importance of foreign exchange as an asset. The internet trading platform has also made it easier for retail traders to trade in the market.
Essentially the foreign exchange market is an over the counter market where the dealers negotiate directly with each another. The biggest foreign exchange trading centre is the UK. Majority of the trade is handled by the institutions like Deutsche Bank, UBS AG, Citigroup incorporated, Royal Bank of Scotland, Barclays Capital, Bank of America, HSBC, Goldman Sachs, JP Morgan, Morgan Stanley.
These large international banks frequently provide the market with buy and sell prices of the different currencies. Minimum trading size for most of the deals is usually kept at 100,000 units of that particular currency; this is a known popularly as a standard lot. Unlike a stock market, the foreign exchange market is divided into levels of access. This is due to volume of transactions. Central banks of various countries also participate in the market to align currencies to their economic needs.
The bank may trade on behalf of customers, but much of the trading is done by the banks for their own account. A major fraction of this market comes from the financial activities of various companies seeking foreign exchange to pay for goods or services, their trades often have small/ big short term impact on market rates. There are two types of retail brokers who participate in the market such as the brokers offering speculative trading and brokers offering physical delivery of the bought currency.
The foreign exchange rate fluctuations are generally caused by actual currency flows as well as by expectations of changes in currency flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses and other economic conditions of that particular country. The foreign currencies are traded against one another; each pair of currencies thus constitutes an individual product. Although exchange rates are affected by many factors, in the end, currency prices are a result of supply and demand forces, thus its value, are not influenced by any single element, but rather by several.
There are few specific terms that are used frequently in the foreign currency trade like spot. A spot transaction is a two-day delivery transaction, this trade represents a direct exchange between two currencies, it involves the shortest time frame. Next is the Forward, in this type of transaction, money does not actually change hands until some agreed upon future date. Another is the swap, in a swap; two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. Speculation also plays a major part in the foreign exchange market and it may cause some currencies to fall or gain for a short time period.