Financial Markets. Forex Market
Foreign Exchange Market (FX, Forex)
Definition
The foreign exchange market is a global, decentralized system for exchanging one currency for another, facilitating international trade, investments, and capital flows between countries. It is the largest financial market in the world by daily trading volume (over $7 trillion per day according to BIS data).
FX does not create value by itself – it reflects the relationship between economies, interest rates, and capital flows.
Purpose
FX performs three key functions:
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Facilitating international settlements
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Hedging currency risk
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Redistribution of global capital
International trade is impossible without FX. When a country imports oil, it buys it in another currency, which creates demand for that currency.
Market Structure
FX is an OTC (over-the-counter) market. This means:
– No centralized exchange
– No single order book
– No single regulator
Pricing is formed through a network of banks that quote bid/ask to each other. Large banks form the “interbank market.” Brokers gain access to this liquidity or aggregate it through liquidity providers.
A retail trader does not have direct access to the interbank market.
Main Participants
Central banks – manage reserves and conduct interventions
Commercial banks – provide liquidity
Institutional funds – manage international portfolios
Corporations – hedge currency risks
Hedge funds – speculate on macro expectations
Retail traders – speculative segment
The retail segment accounts for less than 10% of global turnover.
Currency Pair
In FX, a "currency" is not traded, but a pair.
EUR/USD means:
How many dollars are needed to buy 1 euro.
The first currency is the base currency.
The second is the quote currency.
The movement of the pair reflects the change in the relative strength of economies.
Main Drivers
FX reacts not to events, but to expectations.
Key factors:
– Interest rate differential
– Inflation
– Monetary policy
– Economic growth
– Balance of payments
– Geopolitics
If the Fed is expected to raise rates faster than the ECB, the USD strengthens even before the actual decision.
Trading Hours
FX operates 24 hours a day from Monday to Friday.
Main sessions:
Asian
European (London)
American (New York)
Highest liquidity – during the London–New York overlap.
Lowest liquidity – end of Friday and opening of Monday.
Liquidity
FX is the most liquid market in the world.
This means:
– Low spreads
– Fast execution
– Minimal impact of a single order on price
However, liquidity is not uniform.
During news events, volatility spikes and wider spreads are possible.
CFDs in Forex
Retail trading is usually done through CFDs (Contract for Difference).
A CFD is a contract with a broker on the difference between the entry and exit price.
You do not buy actual currency. You do not access the interbank market. You enter into a financial agreement with a broker.
Advantages:
– High leverage
– Access with small capital
– Simplicity
Disadvantages:
– Counterparty risk
– Execution model depends on the broker
– Potential conflict of interest
CFDs are a derivative instrument, not physical trading.
Leverage
FX allows high leverage (1:30, 1:50, and more depending on jurisdiction).
A 1% movement in the forex market is considered significant.
With 1:30 leverage, this means a 30% change in margin.
Leverage increases both profit and liquidation risk.
Volatility
FX is less volatile than crypto or stocks, but more stable in trending phases if the movement is supported by interest rate changes.
Currency markets rarely move chaotically without a fundamental reason.
FX vs. Other Markets
FX vs. Stocks:
Stocks reflect company earnings.
FX reflects the value of money and capital flows.
FX vs. Bonds:
Bonds often move first.
FX is a secondary reaction to interest rate changes.
FX vs. Futures:
FX is OTC.
Futures are centralized.
FX vs. Options:
FX is spot or forward.
Options are trading volatility and the right, not the obligation.
Risks
– Leverage risk
– News risk
– Geopolitical gaps
– Illiquidity during off-hours
– Counterparty risk in CFDs
Role of FX in the Global System
FX is a channel for monetary policy transmission.
When a country lowers its rate, its currency weakens, stimulating exports.
When the rate increases, the currency strengthens, curbing inflation.
The exchange rate is an economic balancing mechanism.
Summary
The foreign exchange market is the largest, most liquid, and most macro-dependent financial market in the world.
It operates 24/5, has no centralized exchange, is driven by interest rates and capital flows, and is a fundamental indicator of the global economy.
For a trader, FX is not just a pair on a chart.
It reflects the strength of economies, monetary policy, and confidence in a currency.