While the New York Stock Exchange gets most of the attention, as does the Dow Jones, there are several other markets that people can look to in order to make money on investments. One such market, that most don’t trade in, is the FOREX market. FOREX, which stands for Foreign Exchange Market, involves the trading of currencies. The main participants within this market tends to be large banks that span international borders. The FOREX actually determines the values of different currencies and has a huge impact on our lives in terms of economics.
The FOREX market works through financial institutions, operating on different levels. Banks, behind the scenes, work with dealers who are involved in huge amounts of foreign exchange trading. Most dealers are banks, and as a result the behind-the-scenes market is called an interbank market. That doesn’t meant that only banks are involved. Other financial firms and insurance companies are involved.
Trades between dealers can be quite huge, often reaching millions of dollars in size. FOREX helps with international trade because it allows for the conversion of currencies. For example, this allows businesses within the United States to import goods from the European Union, despite the two entities using completely different currencies. The European states pay in Euros, while the United States reports it as dollars in their income.
The modern FOREX market emerged in the 1970s after three decades of restrictions by governments around the world. As countries began to move to floating exchange rates, things began to change and the market was born in its current version.
The FOREX market is unique for several reasons including the fact that it has a huge trading volume that represents the largest asset class on the planet. There is also a huge amount of geographic dispersion. The market runs 24 hours a day, except on weekends, and it has low margins of relative profit.
So, how much is actually traded? Here is just a brief idea of the huge amounts of money that go through the FOREX market. According to the Bank of International Settlements, roughly $5.3 trillion per day is traded, up from $4 trillion only three years previous and $3.3 trillion six years previous. According to the same organization, the daily turnover in global foreign exchange markets is as high as $3.98 trillion, a growth of 20 per cent over 2007. This breaks down to $1.49 trillion in spot transactions, $475 billion in outright forwards, $1.765 trillion in foreign exchange swapping. $207 billion in options and $43 billion in currency swaps.
The top currency trader in the world is Deutsche Bank, which has a 15.18 per cent market share. This is followed by Citi Bank at 14.9 per cent, Barclays Investment Bank at 10.24 per cent, UBS AG at 10.11 per cent and HSBC at 6.93 per cent. In the top ten currency traders, the United States has four banks, followed by two banks in the United Kingdom and two banks in Switzerland.
Generally, individuals do not trade in the FOREX market but they can earn money through their pension funds. The entire FOREX market is actually divided into different access levels. The top level is the interbank level, which is where the largest commercial banks and dealers are. They account for 39 per cent of all transactions. Below this tier is the smaller banks, followed by the multi-national corporations who use the market to hedge risk and pay employees in different countries.
The next tier is the hedge funds traders, followed by some retail market makers. Pension funds, insurance companies and institutional investors are beginning to play a larger and larger role in the market since the early 2000s. A huge amount of growth was seen in this area from 2001 to 2004.
In terms of the most traded currencies, the United States dollar dominates with 87 per cent of the daily share, followed by the Euro at 33.4 per cent. The Japanese yen rounds out the top three with 23 per cent. Others in the top ten in terms of daily share includes the Pound sterling (11.8 per cent), Australian dollar (8.6 per cent), Swiss franc (5.2 per cent), Canadian dollar (4.6 per cent), Mexican peso (2.5 per cent), Chinese Yuan (2.2 per cent) and New Zealand dollar (2.0 per cent).
Today, the FOREX market plays a huge role in our world economics, allowing multinational companies to exist and be able to pay for goods and services in other countries, while also paying employees in other countries. In addition, it allows banks to transfer funds, which in turn allows individuals to transfer funds to friends, family and companies elsewhere in the world.