What Is the Forex Market?
- The forex market allows participants, including banks, funds, and individuals, to buy, sell or exchange currencies for both hedging and speculative purposes.
- The forex market operates 24 hours, 5.5 days a week, and is responsible for trillions of dollars in daily trading activity.
- The forex market is made up of two levels: the interbank market and the over-the-counter (OTC) market.
Forex Market Basics
Understanding the Forex Market
The foreign exchange (forex) market is the largest financial market in the world and is made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors.
The forex market is not dominated by a single market exchange, but a global network of computers and brokers from around the world. Forex brokers act as market makers as well, and may post bid and ask prices for a currency pair that differs from the most competitive bid in the market.
The number of daily forex transactions registered in April 2019, according to the 2019 Triennial Central Bank Survey of FX and OTC derivatives markets.
The forex market is made up of two levels—the interbank market and the over-the-counter (OTC) market. The interbank market is where large banks trade currencies for purposes such as hedging, balance sheet adjustments, and on behalf of clients. The OTC market, on the other hand, is where individuals trade through online platforms and brokers.
From Monday morning in Asia to Friday afternoon in New York, the forex market is a 24-hour market, meaning it does not close overnight. This differs from markets such as equities, bonds, and commodities, which all close for a period of time, generally in the New York late afternoon. However, as with most things, there are exceptions. Some emerging market currencies close for a period of time during the trading day.
Origins of the Forex Market
Up until World War I, currencies were pegged to precious metals, such as gold and silver. Then, after the Second World War, the system collapsed and was replaced by the Bretton Woods agreement. That agreement resulted in the creation of three international organizations to facilitate economic activity across the globe. They were the:
- International Monetary Fund (IMF)
- General Agreement on Tariffs and Trade (GATT)
- International Bank for Reconstruction and Development (IBRD)
The new system also replaced gold with the U.S. dollar as a peg for international currencies. The U.S. government promised to back up dollar supplies with equivalent gold reserves. But the Bretton Woods system became redundant in 1971 when U.S. President Richard Nixon announced “temporary” suspension of the dollar’s convertibility into gold.
Big Players in the Forex Market
The U.S. dollar is by far the most traded currency, making up 88% of all trades in 2019. Second is the euro, which was part of 32% of all currency trades during that year, and third is the Japanese yen at 17%. Note that these figures do not total 100% because there are two sides to every FX transaction.
Meanwhile, according to a 2020 FX survey conducted by Euromoney, JPMorgan Chase & Co. and UBS were the two biggest traders in the forex market, combining for nearly 19% of the global market share. XTX Markets, Deutsche Bank, and Citigroup made up the remaining places in the top five.