As a result of international commodity and finished product trading activities, the currencies of the major nations of the world usually remain in demand and see active trading on the forex market.
Another factor driving the forex trading is the fact that the foreign exchange market trades around the clock, five days a week. Learn more about the 24 hour forex trading market.
The foreign exchange market is made up of varied participants, many of which have a commercial need to buy or sell currencies. Nevertheless, a great many more market participants in the forex take part with the sole intention of making a profit on foreign exchange transactions. Learn more about the different forex market participants.
Also, the forex market has grown considerably in size and breadth since exchange rates began to float in the modern era in the early 1970’s. The following sections will describe the market and some of the factors behind this remarkable growth.
Main Centers and Currencies
Currently, approximately 60% of forex trading activity is focused in three main trading centers. Listed in order of importance in terms of transaction volume, these centers are London, New York and Tokyo.
The primary major currencies traded in those centers are the U.S. Dollar, the Euro, the Japanese Yen and the British Pound Sterling. Active secondary currencies include the Swiss Franc, the Australian Dollar, the Canadian Dollar and the New Zealand Dollar
Size and Products Traded in the Forex Market
The average daily global turnover in the forex market has been estimated to exceed $3 trillion, making the forex market the largest financial market in the world.
The daily volume broken down by forex products traded is as follows:
- Forex Swaps: $1.7 trillion
- Spot Trades: $1.0 trillion
- Forward Outrights: $0.4 trillion
- Currency Options: $0.2 trillion
Dramatic Growth of the Forex Market
Trading in the forex market has seen dramatic growth since exchange rates began to float again in the early 1970’s. For example, daily forex market turnover in the following years was estimated at:
- 1977: $5 billion
- 1987: $600 billion
- 1992: $1 trillion
- 2000: $1.5 trillion
- 2007: $3 trillion
Forex Growth Factors
A number of factors have influenced the sharp growth in forex trading activity seen over recent years. They include:
- Volatility – changes in exchange rates and interest rates have increased in size and frequency, thereby increasing opportunities for traders.
- Globalization – International trade of finished products and commodities has grown dramatically in recent decades, as companies now shop in a global marketplace for the goods and services they require. The more that international trade increases, the greater the need for foreign exchange to settle such transactions.
- Risk Awareness – companies from around the globe are increasingly aware of how adverse forex moves can affect their overall profitability. This has increased the demand for forex hedging products like forwards and currency options.
- International Investment – Investors are increasingly looking abroad for better yields, as well as currency appreciation opportunities.
- Information Access – The modern era has dramatically improved access to market information, timely news and other fundamental analysis tools.
- Better Communication – Also, the Internet has made forex trading much more accessible for individual traders.
- Greater Computing Power – Advances in computing technology applied to automated trading systems and electronic trade processing have made it possible to execute a larger number of forex deals faster and more reliably. Also, the use of computers for risk management and technical analysis software has greatly improved the speed sophistication of the trade analysis process.
The Benefits of Liquidity in the Forex Market
The meaning of liquidity in the world of trading refers to how much trading activity occurs in an asset over a certain time frame, as well as the ability to convert an asset into a cash position quickly.
For example, the real estate market does not qualify as a very liquid market. The time between owning a real asset and liquidating the property can take years in some cases. Not so in the forex market, spot delivery is generally a two day settlement period, except for the U.S. Dollar versus the Canadian Dollar which is one day.
Why is liquidity important to traders? Because a liquid market prevents market pricing vacuums where a lack of orders to either buy or sell can create wild price swings. Also, a liquid market guarantees a certain degree of orderliness.
Liquidity also provides traders with lower execution costs and tighter bid/ask spreads which also contributes to keeping the trader’s overall costs down.
Nevertheless, even the huge currency market can become illiquid at times. While rare, this can occur due to economic, political or other news events or extremely volatile price action that causes trading to thin out due to less participants being willing to make prices or take positions.
Diversity in Trading Instruments
In addition to the unparalleled liquidity of the forex market, a number of different trading options exist for the serious trader. The different types of contracts traded on currencies include:
- Spot trades
- Contracts for Difference
- Currency Exchange Traded Funds or ETFs
- Options, both Vanilla and Exotics
Furthermore, various combinations of the above forex trading vehicles can be incorporated into a currency trading strategy to maximize profits and manage risk according to a specific market view. Read more on different forex trading instruments.
Overall, the forex market offers many advantages for the personal and institutional trader alike.