What is the 'Foreign Exchange'

Foreign exchange is the exchange of one currency for another or the conversion of one currency into another currency.

Foreign exchange also refers to the global market where currencies are traded virtually around the clock. The largest trading centers are London, New York, Singapore and Tokyo. The term foreign exchange is usually abbreviated as "forex" and occasionally as "FX."

BREAKING DOWN 'Foreign Exchange'

Foreign exchange transactions encompass everything from the conversion of currencies by a traveler at an airport kiosk to billion-dollar payments made by corporations, financial institutions and governments. Transactions range from imports and exports to speculative positions with no underlying goods or services. Increasing globalization has led to a massive increase in the number of foreign exchange transactions in recent decades.

The global foreign exchange market is the largest financial market in the world, with average daily volumes in the trillions of dollars. Foreign exchange transactions can be done for spot or forward delivery. There is no centralized market for forex transactions, which are executed over the counter and around the clock.

Spot Market

Spot for most currencies is two business days; the major exception is the U.S. dollar versus the Canadian dollar, which settles on the next business day. Other pairs settle in two business days. During periods that have multiple holidays, such as Easter or Christmas, spot transactions can take as long as six days to settle. The price is established on the trade date but money is exchanged on the value date.

The U.S. dollar is the most actively traded currency. The most common pairs are the dollar versus the euro, Japanese yen, British pound and Swiss franc. Trading pairs that do not include the dollar are referred to as crosses. The most common crosses are the euro versus the pound and yen.

The spot market can be very volatile. Movement in the short term is dominated by technical trading, which focuses on direction and speed of movement. People who focus on technicals are often referred to as chartists. Long-term currency moves are driven by fundamental factors such as relative interest rates and economic growth.

Forward Market

A forward trade is any trade that settles further in the future than spot. The forward price is a combination of the spot rate plus or minus forward points that represent the interest rate differential between the two currencies. Most have a maturity less than a year in the future but longer is possible. Like with a spot, the price is set on the transaction date but money is exchanged on the maturity date.

A forward contract is tailor-made to the requirements of the counterparties. They can be for any amount and settle on any date that is not a weekend or a holiday in one of the countries.

Futures Market

A futures transaction is similar to a forward in that it settles later than a spot deal, but it is for a standard size and settlement date and is traded on a commodities market. The exchange acts as the counterparty.

  1. Spot Trade

    A spot trade is the purchase or sale of a foreign currency or ...
  2. Forex - FX

    The market in which currencies are traded. The forex market is ...
  3. Spot Date

    The spot date is the date at which a transaction is settled.
  4. Forward Market

    A forward market is an over-the-counter marketplace that sets ...
  5. Forex Spot Rate

    The forex spot rate is the most commonly quoted forex rate in ...
  6. Currency ETF

    Currency ETFs aim to replicate movements of a single currency ...
Related Articles
  1. Trading

    Combining Forex Spot And Futures Transactions

    The spot, futures and option currency markets can be traded together for maximum downside protection and profit.
  2. Investing

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  3. Investing

    Currency Positions You Can Take Now

    The foreign currency market is the largest financial market in the world, and investors in this market have many options.
  4. Investing

    Introduction To Currency Futures

    The forex market is not the only way for investors and traders to participate in foreign exchange.
  5. Trading

    The Currency Market Information Edge

    Unique features of the forex market may allow larger players to get a jump on smaller ones.
  6. Trading

    How to Calculate an Exchange Rate

    Struggling to get a grasp on exchange rates? Here's what you need to know.
  7. Trading

    How To Lock In An Exchange Rate

    Currency risk can be effectively hedged by locking in an exchange rate through the use of currency futures, forwards, options, or exchange-traded funds.
  8. Trading

    Forex Market Basics

    The foreign exchange market is a market where participants buy, sell, and exchange trillions of dollars worth of currencies daily. Learn the basics of the FX market.
  1. What is the difference between trading currency futures and spot FX?

    The forex market is a very large market with many different features, advantages and pitfalls. Forex investors may engage ... Read Answer >>
  2. What is the Difference Between a Forward Rate and a Spot Rate?

    The forward rate is the settlement price of a forward contract, while the spot rate is the settlement price of a spot contract. Read Answer >>
  3. What are some securities that have spot rates?

    Learn about the types of assets that have spot rates, and understand how the spot rate is used to determine the fair market ... Read Answer >>
  4. What is foreign exchange?

    Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's ... Read Answer >>
  5. How do I find out my bank's bid-ask spread for currency conversions?

    Learn how to find your bank's bid-ask spreads for currency conversions, and understand why you should consider alternative ... Read Answer >>
  6. How can I trade in cross currency pairs if my forex account is denominated in U.S. ...

    The forex market allows individuals to trade on nearly all of the currencies in the world. However, most of the trading is ... Read Answer >>
Hot Definitions
  1. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  2. Entrepreneur

    An Entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture. ...
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  5. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  6. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
Trading Center