FOREX

The Foreign Exchange Market

Introduction to FOREX
 The foreign exchange market (currency, forex, or FX) is where
currency trading takes place.

 The foreign exchange market is a global decentralized or over-the-counter (OTC)

market for the trading of currencies

This market determines foreign exchange rates for every currency. It includes all

aspects of buying, selling and exchanging currencies at current or determined
prices.

 "Foreign Exchange" is the simultaneous buying of one currency and selling of

another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or
US Dollar/ Pound sterling (USD/GBP).

 In terms of trading volume, it is by far the largest market in the world,

followed by the credit market
About Forex
 The main participants in this market are the larger international banks which
trade in lots, called micro, mini, and standard lots. A micro lot is 1000 worth of
a given currency, a mini lot is 10,000, and a standard lot is 100,000.

 The forex market is unique for several reasons, mainly because of its size.
Trading volume is generally very large. Trading in foreign exchange markets
averaged $6.6 trillion per day in April 2019, according to the Bank for
International Settlements.

 The largest foreign exchange markets are located in major global financial
centers like London, New York, Singapore, Tokyo, Frankfurt, Hong Kong, and
Sydney, making the forex market open 24 hours a day, five days a week
across major financial centers across the globe.

 The purpose of FX market is to facilitate trade and investment, to allow

international capital arbitragearound the world.
Trading volume

 Average daily turnover in global foreign exchange markets

is estimated at $6.6 trillion.

 The Break Up of this $6.6 T is as follows:

$2 trillion in spot transactions
$1 trillion in outright forwards
$3.2 trillion in foreign exchange swaps
$294 billion estimated gaps in reporting
 85% of all daily transactions involve trading a group of currencies known
as the "Majors" (the U.S. dollar (USD), the Canadian dollar (CAD), the
Euro (EUR), the British pound (GBP), the Swiss franc (CHF), the New
Zealand dollar (NZD), the Australian dollar (AUD) and the Japanese yen
(JPY)).
Unique FOREX Market
 Its trading volumes
 The extreme liquidity of the market.
 The vast geographical dispersion
 the low margins of profit compared with other
markets of fixed income (but profits can be
high due to very large trading volumes)
 its long trading hours
Major Players
 According to the BIS study, the most heavily
traded products in 2019 were
2. EUR/USD: 28%
3. USD/JPY: 13%
4. GBP/USD (also called sterling or cable): 11%
 The US currency was involved in 88.3% of
transactions, followed by the euro (32.3%), the
yen (16.8%), and sterling (12.8%)
 The romanian leu is the 35th most traded
currency, involved in only 0.1% transactions.
Trade in FOREX
 On Forex, trading happen without physical exchange of money from one party
to another. Traders are usually taking a position in a specific currency, with
the hope that there will be some upward movement and strength in the
currency they're buying (or weakness if they're selling) so they can make a
profit.
 Most brokers provide leverage, some up to 50:1. For the 20:1 leverage,
traders only need $250 in their account (because $250 * 20 = $5,000).

 Making a profit of $25 quite quickly considering the trader only needs $500 or
$250 in the capital, shows the power of leverage. The flip side is that if this
trader only had $250 in their account and the trade went against them they
could lose their capital quickly.

 It is recommended traders manage their position size and control their risk so
that no single trade results in a large loss.
How to Read a Currency Quote

 currency pair
 base currency
 quote currency
 Bid price
 Ask Price
Two components to Forex
 Forex has two components

Over-the-counter (OTC)
Organized exchanges

 OTC is a network of dealers, brokers, and final customers. Low

regulation
 Dealers are mostly commercial and investment banks that buy a
currency at a bid price and sell it at an ask price
 Dealers take a position and thus face a risk of a price change
between purchase and sale
 Biggest dealers are Deutsche Bank, UBS, Citigroup, HSBC,
Barclays Bank, J.P. Morgan Chase, Goldman Sachs, ABN
AMRO, and Morgan Stanley
 Brokers help in carrying out a deal, connecting a dealer with a
final buyer or seller. They receive a fee and take no
exchange rate risk
Types of transactions
 Spot
 Outright exchange of one currency for another at the current spot
price with a two-day settlement.
 Currency covers both actual currency and bank deposits.
 Large transactions are in deposits.

Outright forward

Outright exchange of one currency for another at the current

 market price but with future delivery.
Transaction used to be done typically in agriculture. An Italian
exporter of Parmigiano cheese to the US, with an invoice due in
 60 days, would sell forward the dollars against liras.
The price is calculated by adjusting the spot rate to account for
the difference in interest rates between the two currencies
Types of transactions
Forex swap (two legs)

 In the first leg there is a swap of one currency for another

 In the second leg, which occurs in the future, there is a re-exchange, that
is the opposite swap
 The swap can occur with the first leg, say, in one month, and the second
in three months

Currency swap (three legs)

 First: a spot exchange of two currencies with underlying assets

 Second: an exchange of flows of fixed or floating interest rate payments
 Third: a re-exchange of the currencies at the initial spot rate
 It thus combines an interest rate swap with a forex swap
Example of a FOREX trade
 Assume a trader believes that the EUR will appreciate against
the USD. Another way of thinking of it is that the USD will fall
relative to the EUR.
 They buy the EUR/USD at 1.2500 and purchase $5,000
worth of currency. Later that day the price has increased to
1.2550. The trader is up $25 (5000 * 0.0050). If the price
dropped to 1.2430, the trader would be losing $35 (5000 *
0.0070).

 Currency prices are constantly moving, so the trader may

decide to hold the position overnight. The broker will
rollover the position, resulting in a credit or debit based on
the interest rate differential between the Eurozone and the
U.S. If the Eurozone has an interest rate of 4% and the
U.S. has an interest rate of 3%, the trader owns the higher
interest rate currency because they bought EUR.
Best time for trading?
The chart shows the currency pairs activity depending on the time of
the day. The pairs were selected in such a way as to visually
demonstrate the influence of a region on the “tradability” of a pair.
The most active trading hours in the Forex market are 7:00-16:00 (UTC).
While the lowest level of currency pairs movement is from 3:00 to 7:00
(UTC).
The peak of currency pairs’ activity is observed when the London and the
New York trading sessions overlap. The most “traded time” is 15:00 (UTC).
If countries have the same trading sessions (working hours), the currency
pair will be actively traded only within the given session. As you can see in
the chart above, USDCAD ignores the London session opening. Other pairs
– EURGBP and AUDNZD – do the same.
Tools for determining future
movements in Money
Market
 Fundamental Analysis
Thorough analysis of economic and political data
with the goal of determining future movements in
a financial market.

 Technical Analysis
An effort to forecast future market activity by
analyzing market data such as charts, price trends,
and volume.
Types of Forex risk
 Translation risk: Multinational co. (MNC) with branches
or subsidiaries in different currency areas of the world
must report its consolidated financial accounts in a
single currency. The conversion creates gains or
losses and may have tax consequences.
 Transaction risk: Arising from transactions in different
currencies.
 Economic risk: Typical in a foreign direct investment
(FDI). Investment is valued in terms of discounted
 cash flows in foreign currencies and then converted in
local currency, with the local discount rate.
References
 https://en.wikipedia.org/wiki/Foreign_exchange_market
 Bank for International Settlements December 2019
 https://www.investopedia.com/terms/f/forex.asp
 https://www.investopedia.com/articles/forex/11/why-trad
e-forex.asp
 https://fxssi.com/the-most-traded-currency-pairs
 https://www.easymarkets.com/eu/learn-centre/discover-t
rading/currency-trading-explained/