Foreign exchange

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Foreign exchange, "FOREX" or "FX," refers to global currencies as well as to exchanges, markets and products used for trading various world currencies.

"FOREX" has been synonymous with the cash foreign currency markets, both the vast over-the-counter[1] professional market and the retail Forex market that has sprung up since the turn of the 21st century.

Forex is the most actively traded market in the world; its value far exceeds the total value of trading in all the stock and futures markets combined. A common estimate of the value of forex transactions daily is $1.9 trillion, but it is hard to say for certain, because most of the trading takes place between parties in the Interbank network of large financial dealers, without any exchange or central source to execute and track the transactions.[2]

Foreign currency trading can be done on three main venues: the Interbank market, cash forex firms or exchange-traded futures and options. Although the term "FOREX" is perhaps the most descriptive acronym for trading in global currencies, exchanges have tended to steer away from using FOREX as a term describing their foreign currency futures and options business to avoid being categorized as part of the growing retail FOREX markets, which in some quarters have experienced regulatory and enforcement difficulties.[3]


The advantages of trading (retail) cash forex include:

  • Low entry cost and high leverage
  • No commissions or fees. (Cash forex firms make their money on the difference in the bid/ask spread)
  • Easy-to-use electronic trading platforms and live quotes

The advantage of trading forex futures include:

  • Trading on a centralized market with many sources providing bid/ask input. The competitive environment produces tight bid/ask spreads.
  • Transparent pricing for traders of all sizes at the same time
  • No counterparty risk, because the exchange’s clearing house acts as the counterparty to every trade

History

For years, participation in the Interbank forex market was limited to central banks, major financial institutions and large dealers, and retail investors did not have access. Trading in the over-the-counter market occurred between two parties who specified their own terms.

A few years after the United States ended the gold standard in 1971, Leo Melamed and other Chicago Mercantile Exchange officials, with the support of Milton Friedman, recognized the potential for a futures contract in forex. The CME launched the International Monetary Market to trade seven foreign currency futures contracts on May 16, 1972.

These were the world’s first successful financial futures contracts, opening the way for interest rate, stock index and other innovative financial contracts.[4]

Trading in forex futures developed slowly, and it was not until 1996 that firms offering forex trading to retail traders began to pop up. The Internet was instrumental in providing a communications link between online market-making firms and retail traders. With only a few hundred dollars, a trader could open up an account with a firm to trade cash forex.[5]

Modern Foreign Exchange Markets

Regulation

Mechanics

Trading Platforms

See Also

"Trading in the Retail Off-Exchange Foreign Currency Market - What Investors Need to Know," National Futures Association

References

  1. CME Glossary. CME.
  2. "Trading FX". SFO Magazine.
  3. "National Futures Association Forex Investor Alert: February 2007”. National Futures Association.
  4. CME Group - The futures of capitalism. The Economist.
  5. "Trading FX: Money Makes the World Go Round". SFO Magazine.