Forex (Foreign exchange) is the market on which currencies are traded worldwide. Just like a stock or commodity whose price changes daily, a currency’s price changes daily in relation to other currencies.
Exchange rates are, therefore, the result of price variations on the Forex, the foreign exchange market. For example, the Euro Dollar (EUR/USD) exchange rate changes daily on the Forex market. If the Euro Dollar rate is equal to 1.30, it means that for 1 Euro, you can receive 1.30 Dollars, excluding exchange fees.
The foreign exchange market is the largest in the world regarding trading volume, second only to the debt market but well ahead of the equity market, as we will see below. Unlike the stock markets (shares, interest rates, commodities…), which have a precise geographical and legal location, there is only one foreign exchange market: international.
Currency transactions are carried out over-the-counter (OTC) in Paris, London, New York, Sydney, and Tokyo. Due to the time difference between the various financial centers, the foreign exchange market operates continuously, 24 hours a day, from Sunday evening to Friday evening. At any time of the day, it is, therefore, always possible for a private individual or a market operator to buy euros, dollars, or any other currency.
Forex in figures
In terms of trading volume, Forex is the second largest market in the world after the interest rate market. For 2010, the average daily trading volume was 3.981 trillion dollars, of which 1.1 trillion were traded in the Euro/Dollar (EUR/USD) exchange rate alone. By way of comparison, in the same year, the average daily trading volume was:
- 74 billion on Wall Street, the New York Stock Exchange,
- 18 billion on the Tokyo Stock Exchange,
- 7 billion on the London Stock Exchange.
Forex is a global and very liquid market, meaning that a currency buyer will systematically find a seller and vice versa. A foreign exchange transaction is, therefore, instantaneous. The figures for Forex are provided by the Bank for International Settlements BIS. The Bank for International Settlements is located in Basel and is also known as the bank of central banks.
Since 2001, the growth of Forex has been exponential, mainly due to the development of broadband Internet and the lowering of transaction fees. Broadband Internet has dramatically increased the possibilities for high-frequency trading in investment banks. It has opened up the Forex market to retail investors.
Can an individual buy and sell currencies?
If you have ever traveled outside of the Eurozone, you have gone to a currency exchange to exchange Euros for the currency of your destination country. By giving the order to your intermediary (the exchange office) to exchange your Euros for another currency, you have carried out a transaction on Forex, the foreign exchange market.
Any private individual can therefore intervene in the foreign exchange market, and you have already done so during your last visit to a foreign exchange office. When you exchanged your Euros for Dollars, you bought and sold Euros. You have therefore bought the Euro Dollar exchange rate. A private individual can, therefore, like banks and traders, buy and sell currencies in the nearest exchange office.
Basic forex vocabulary?
Before going into detail about how the currency market works, it is essential to remember that a currency’s value does not change independently of other currencies. The value of a currency is, by definition, expressed in terms of another currency.
Forex is, therefore, the comparison of all currencies against each other. In practice, a currency always quotes against another currency. The Eurozone currency, the Euro, can be quoted against the Dollar, the Pound Sterling, and the Yen…
The Euro currency can gain value against the Dollar but lose value against the Pound Sterling simultaneously. A currency expressed against another currency forms a currency pair. What you are used to calling an exchange rate (e.g., Euro Dollar is worth $1.35) is usually called a currency pair in Forex. Basic vocabulary:
- The Euro is a currency, and (EUR) is its symbol,
- The Dollar is a currency, and (the USD) is its symbol,
- The Euro Dollar is a currency parity (or a currency pair), and (EUR/USD) is its symbol,
- An exchange rate is an expression at a time “t” of the exchange rate of the Euro Dollar currency pair,
- In a currency pair, the currency on the left (the one quoted first) is said to be quoted at a certain or called the base currency. This other currency is quoted as uncertain or called the counter currency. Its value in the pair is always equal to 1, while the value of the other currency varies.
The Dollar (USD) is the counterpart currency quoted at the uncertain and 1 EUR = 1.3000 USD. This is the parity of the Euro against the Dollar. For example, in the quote EUR/USD = 1.3000, the Euro (EUR) is the base currency.
Forex hours and trading
The forex market is open 24 hours daily, and currency pairs are quoted continuously. But activity in the Forex market varies in each geographical area according to time slots. For example, when it is dark in Europe, Asia is in the middle of the day. It concentrates most of the activity in the currency market. This is known as the Forex sell-off in each region. Below, you will find the times of each Forex session, expressed in Paris time:
- The European sell-off (8am/6pm): the European market starts with the opening of London at 8am and closes at 6pm. This is the most dynamic session regarding trading volume on the Forex market, mainly due to the importance of the London financial center on the currency market.
- The American session (1pm-11pm): The United States is the second most important place for Forex according to the 2010 figures of the Bank for International Settlements (BIS).
- The Asian session (11pm/11am): The four main financial centers of the Asian sell-off are Tokyo, Hong Kong, Singapore, and Sydney.
Logically, the most active periods in terms of trading volume on Forex are the periods of the simultaneous opening of the different Forex sessions. Therefore, the most crucial period is the 1:00 pm ET to 6:00 pm ET time slot, the simultaneous opening phase of Europe and the United States.