Foreign currency exchange is the value of one currency stated in terms of another currency. A person who exchanges one country’s money for currency issued by another country has acquired foreign exchange.
The foreign exchange (also known as the currency, forex or FX) market exists wherever one currency is traded for another. It is the largest and most liquid financial market in the world and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions.
The average daily trade in the Global Forex and related markets is currently almost US$ 4 trillion.
Foreign Currency Exchange Market Size and Liquidity
The FX market has been referred to as the market closest to ideal or perfect competition, notwithstanding market manipulation by central banks.
According to the BIS, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion. Trading in the world’s main financial markets accounted for $3.21 trillion of this.
Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London the global centre for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo 6.0%.
Foreign currency exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management as sets, particularly of hedge funds and pension funds.
The diverse selection of execution venues such as internet trading platforms has made it easier for retail traders to trade in the foreign exchange market.
Because foreign currency exchange is an OTC (Over The Counter) market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house.
The Cost of a Foreign Currency Exchange Trade
Trading in the FX market is commission free, but it is not free to trade. Instead of your broker charging you a commission, you pay a spread, i.e. Pips (points). This means that you give away a number of Pips per trade to the Broker.
The Bid/Ask Spread is the difference between the price at which a bank or market maker will sell (“ask”, or “offer”) and the price at which a market-maker will buy (“bid”) from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 3 Pips.
For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 for a retail broker. Minimum trading size for most deals is usually 100,000 units of currency, which is a standard “lot”.
These spreads might not apply to retail customers at banks, which will routinely mark up the difference. Spot prices at market makers vary but on EUR/USD are usually no more than 3 pips wide (i.e. 0.0003).
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