Foreign Exchange Market

The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Retail traders (small speculators) are a small part of this market. They may only participate indirectly through brokers or banks and may be targets of forex scams.

Market size and liquidity

The foreign exchange market is unique because of:

• its trading volume,
• the extreme liquidity of the market,
• the large number of, and variety of, traders in the market,
• its geographical dispersion,
• its long trading hours - 24 hours a day (except on weekends).
• the variety of factors that affect exchange rates,

Average daily international foreign exchange trading volume was $1.9 trillion in April 2004 according to the BIS study Triennial Central Bank Survey 2004

• $600 billion spot
• $1,300 billion in derivatives, ie
  • $200 billion in outright forwards
  • $1,000 billion in forex swaps
  • $100 billion in FX options.

Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, but only accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).

Top 10 Currency Traders

% of overall volume, May 2005

Rank	Name	% of volume
1	Deutsche Bank	17.0
2	UBS	12.5
3	Citigroup	7.5
4	HSBC	6.4
5	Barclays	5.9
6	Merrill Lynch	5.7
7	J.P. Morgan Chase	5.3
8	Goldman Sachs	4.4
9	ABN AMRO	4.2
10	Morgan Stanley	3.9

The ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually only 1-3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203. Minimum trading size for most deals is usually $1,000,000.

These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' cheques. Spot prices at market makers vary, but on EUR/USD are usually no more than 5 pips wide (i.e. 0.0005). Competition has greatly increased with pip spreads shrinking on the majors to as little as 1 to 1.5 pips.