The forex market is one of the largest financial markets in the world where the users are allowed to buy, sell or exchange currencies. This can be done for hedging and tentative reasons. However, this market comprises banks, financial institutions, commercial companies, central banks, hedge funds, retail forex brokers, investment management firms, and investors. It operates 5.5 days a week for 24 hours non-stop.
Moreover, the forex market is responsible for trillions of dollars used in daily trading activities. Undoubtedly forex trading brings in huge investment returns, but the potential risks are similar. The foreign exchange market consists of two levels: the over-the-counter market and the interbank market. As a trader, you can also open a forex account with a minimal investment of $100. Now, let us understand in detail the history of the forex market and the types of this market.
Understanding The Forex Market
You must think that the foreign exchange market is governed and dominated by a single market exchange, but that is not the case. Instead, it is ruled by a global network of computers and brokers from all over the world. These foreign exchange brokers act as the market makers. For example, they post a bid where they ask for prices for currency pairs which might differ from the most competitive bid present in the market.
There are two basic levels of the foreign exchange market. These are:
- The interbank market is where the large commercial banks trade currencies for purposes like balance sheet adjustments and hedging for their clients.
- The second is the over-the-counter market, where individuals have the liberty to trade their currencies through online platforms and brokers.
According to the results of the April 2019 survey of the Triennial Central Bank of Forex and OTC derivatives market, it was seen that nearly 6.6 trillion forex transactions happen daily.
The forex market is a 24-hour open trading market, a Monday morning in Asia or a cosy afternoon in New York. The market is open for trading from Sunday at 5 pm EST to Friday at 4 pm EST. However, these are not subject to change as they differ from markets such as equities, commodities and bonds. Such markets are likely to close for a stipulated period, especially during the late afternoon hours.
History Of The Forex Market
Until World War 1, the currencies were pegged to some prominent and precious metals like silver and gold. Later, during World War 2, the system was converted to the Bretton Woods Agreement. As a result of this agreement, the market saw the emergence of three international organizations. These are:
- General Agreement on Tariffs and Trade
- International Monetary Fund
- International Bank for Reconstruction and Development
However, these markets are known for facilitating economic activities across the globe.
This new system also replaced gold for the US dollar as a peg for the international currencies. Further, the US government then promised to back up their dollar supplies equivalent to the gold reserves. But the Bretton Woods system became redundant on the convertibility of gold. However, in the present scenario, the currencies are free to select their peg, and the value of the peg is then determined by the demand and supply chain of the international markets.
Types Of Forex Market
Presently, there are three types of foreign exchange markets: spot, forward and future. So let us check them in detail.
Spot Forex Market
The spot foreign exchange market is the instant exchange of currencies between the buyers and the sellers following the current exchange rate of the market. The main participants of the spot market are investment, commercial and central banks in the form of dealers, speculators and brokers. The huge investment and commercial banks make up the major portion of spot trades. They not only trade for themselves, but they also trade for their customers.
Forward Forex Market
In the case of the forward foreign exchange market, two parties agree to trade currencies at a fixed rate and quantity shortly. No currency can be exchanged when the trade is initiated. Moreover, these two parties can be individuals, different companies, governments and others. These markets are incredibly useful for hedging. But, the forward markets lack centralized trading and are much more illiquid. In addition to this, there is always a counterparty risk associated with the trade.
Futures Forex Market
The basic function of the forward foreign exchange market and the futures foreign exchange market is the same. The most significant difference between the markets is that the futures forex market uses centralized exchanges. Because of these centralized exchanges, neither party has counterparty risks. Eventually, this ensures that the market is highly liquid compared to the forward foreign exchange market.
The Bottom Line
The US dollar is the most tradable currency, followed by the Euro and the Japanese Yen. The forex market is a marketplace for different traders to purchase, sell or exchange their currencies for the value of another currency. As a result, it is an extremely liquid financial market compared to other financial institutions and markets. However, there is no central marketplace for currency exchange in the foreign exchange market.