What is forex trading?

Forex trading is the speculative exchange of one floating currency for another, with the expectation of earning a profit, and the risk of taking a loss, on fluctuations in the rate of exchange.

This foreign exchange is a huge market, with a current turnover of US$3.2 trillion per day, as reported by the Bank of International Settlements’ latest triennial report, released April of 2007. Trading participants include commercial and central banks, hedge funds, major corporations, large investors, and private individuals, who access the forex market through retail trading platforms acting as brokerages. Approximately 5% of this turnover is for purposes that actually require a change of currency, such as travel, import-export, etc.; the remaining 95% is speculation for profit.

The currencies traded have been standardized into pairs by the IMF. The most active ones are the U.S. dollar (one-half of 86.3% of all trades), the Euro (37%), the Japanese yen (16.5%), the pound sterling (15%), the Swiss franc (6.8%), and the Australian and Canadian dollars (around 6% each). (As there are two currencies involved in each transaction, percentages will total to 200%.) These “majors,” as they are called, represent approximately 90% of the trading on the forex market, or around US$2.88 trillion per day.

More minor currencies such as the New Zealand dollar or the Mexican peso, as well as gold and silver, can also be traded in the forex market, however, they are not as active.

Rather than setting exchange rates in the currency of a particular nation, forex prices are measured in Price Interest Points, or “pips” for short. For most currency pairs, the prices are extended to four decimal places, with the yen being the exception at two decimal places.

Brokers quote different prices for buyers than for sellers, with the difference between these prices being referred to as the “spread” of that currency pair. Rather than charging commissions or trading fees, most brokers make their money on this spread, and rising competition amongst brokers for the burgeoning retail forex market tends to keep spreads low.

Almost half of all forex trading is now accomplished via the Internet, although orders telephoned to the interbank still account for 43% of the total market.

It is important to remember that, unlike a stock exchange or commodities market, there is no central marketplace for the foreign exchange, and therefore weekly trading continues in a rolling pattern around the globe without interruption, beginning with Sydney’s and Wellington’s Monday morning and ending with New York City’s Friday evening.

For purposes of trading, the globe is divided into three sections, roughly corresponding to the market centres of each area: Asia Pacific including Australia, New Zealand, Hong Kong, and Singapore; Europe; and North America. Most active is Europe with 53% of an average day’s trading volume, with London being the financial capital of the world and accounting for approximately one-third of all forex trading volume. Volatility for specific currency pairs varies depending upon the time of day, with a pair tending to be most active when both market centres are open.