You’ve probably heard traders or economists talk about “the Forex market” dozens of times.
Since the late 1990s, it has become somewhat of a financial buzz word.
But what does this acronym actually mean?
It’s a combination of “foreign” and “exchange”; and it refers to the largest market in the world: which is the market for currencies. Today, well over 1 trillion dollars per day is traded on the currency exchange market.
This amounts to roughly one thirteenth of the US GDP. This amount absolutely dwarfs what is traded on equity and commodity markets on a daily basis.
So why is exchanging currency so popular? Why do more people want to trade on the currency exchange market than on markets for commodities and equity?
Well, to give a simple answer: many of the people in the market for Foreign exchange aren’t investors. For instance, some of the biggest players in the money exchange market are multi-national corporations, who need to constantly swap currencies, so they can purchase inputs or finished products from producers in other countries.
Other major players in the foreign currency exchange market include federal governments.
They will often purchase other currencies to stabilize their own currency in relation to another.
For instance, if the US Treasury or the Federal Reserve System were to purchase Euros (and subsequently take them off the currency market), the value of the Euro would increase in relation to the dollar.
This would stimulate European demand for American imports while decreasing American demand for European imports.
While the above partly explains why the demand for exchanging money is so great, it does not do so completely.
One other reason why the demand for foreign exchange is so great is because it is the most liquid investment vehicle available. While selling stocks and bonds may take a while and may be dependent on market conditions, selling currencies is usually quite easy.
In fact, most online brokers allow you to trade with “no slippage,” which means that the second you click “sell,” you actually sell the currency you’re holding at the exact swap ratio listed on the trading platform.
This means that you don’t need to worry about getting stuck with a currency that is rapidly declining in value. Rather, you can sell quickly and get out at any moment.
One last factor that has perpetuated the growth of the money exchanging market is international bank holdings.
Not only do banks often exchange currencies for their business account holders when they make transactions, but they also sometimes offer to hold deposits in banks overseas or in different currencies.
This can prove to be quite advantageous for depositors. For instance, if the value of the dollar is climbing rapidly in relation to the yen, Japanese banks may start to put some deposits into dollars.
After the value of the dollar has appreciated significantly, depositors will be able to exchange the dollars for yen, getting back more yen per dollar than was initially deposited.
As you have read, money exchanging is a massive market, which influences the decisions of governments, businesses, banks, and individuals. Not only does Forex allow each of these players to make an extremely liquid investment, but it also makes foreign transactions easier.
It should be noted Forex trading involves substantial risk of loss and is not suitable for all investors.