In general, the foreign exchange market has no centralized exchange, although futures on some currency pairs are traded on major exchanges like the Chicago International Monetary Market or IMM in the United States.
The sections below will cover the primary means of trading in the forex market.
The Over the Counter or OTC Forex Market
Instead of trading primarily via a central marketplace, the foreign exchange market sees the largest amount of trading volume go through a network of forex traders operating in the so-called “over the counter” or OTC market.
These professional traders usually work for major international banks who deal with each other based on credit lines that these financial institutions extend among themselves in the interbank forex market.
They traditionally connected with each other to deal currencies via telephones, direct phone lines or voice brokers. In the more modern electronic era, the interbank market increasingly uses electronic networks like Reuters Dealing 3000 Spot Matching or Electronic Broking Services’ (EBS) Spot Dealing system to trade forex.
The OTC market also includes customers of these financial institutions, who often include major corporations, hedge funds, central banks, and high net worth individuals whose usual transaction
These clients usually deal over the telephone by contacting the customer dealing desk of the bank. They will often be assigned to a particular forex advisor working on that dealing desk who may call or even visit the client to provide timely market commentary or tailored hedging advice.
This OTC forex market generally functions in an orderly fashion, providing sufficient liquidity for most commercial transactions.
The market also offers relatively tight dealing spreads under most conditions, with the most common exception being right after major news announcements or economic data releases as the new information is being discounted by market makers.
Another interesting feature of the OTC forex market is the fact that it maintains its high degree of liquidity despite being virtually unregulated. The relative freedom of the huge forex market demonstrates how people acting in their own best interests can result in an orderly financial market under most operating situations.
Online Forex Trading
The relatively recent rise of the Internet has provided an opportunity for forex brokers to provide pricing on a variety of liquid currency pairs electronically to individual customers who wish to deal forex in smaller amounts of usually less than one million U.S. Dollars.
Rather than trading on credit, these individuals usually place a certain amount of cash as margin in their trading accounts with such brokers in order to be able to take leveraged trading positions in the forex market.
Most of the personal traders using online forex brokers do so in order to speculate on exchange rate movements for the potential profits they hope to earn.
They also generally use electronic forex platforms connected to the Internet via their personal computers in order to execute forex deals.
The Currency Futures Market
Before online forex trading provided access to currency trading for individuals, a number of smaller speculators traded currency futures on a limited number of currency pairs on exchanges.
For example, currency futures and options on currency futures are actively traded on the Chicago International Monetary Market or IMM in the United States.