A Foreign Exchange trade occurs when a party buys a particular currency from someone by exchanging it for another. For example, a trader can buy Japanese Yens (JPY) with his or her US Dollars (USD). The Foreign Exchange market, also known as Forex, is the world’s largest financial market, with a volume of about $2 trillion a day. In comparison, the NYSE only moves about $25 billion per day.

Unlike other financial markets, the foreign exchange market does not have a physical location or a central exchange. We say it is decentralized. It operates 24 hours a day, 5 days a week (3:00 PM PST on Sunday until 1:00 PM on Friday PST) through an electronic network of banks. For that reason is it considered to be an Over The Counter (OTC) market.

Forex prices are essentially influenced by (a) interest-rate differentials between currencies (including expectations of future rates) and (b) the balance of payments between countries. The balance of payments comprises the trade balance (payments for goods and services), the current account (the former + profits, interest and dividend repatriation) and the financial or capital account. In today’s forex market, significant changes in the financial account resulting from financial crises can have a tremendous impact on exchange rates (e.g. unwinding of yen carry trades).

Some FX markets can be influenced by Central Bank action (or inaction) - a sterilisation operation or other open market operation to devalue or revalue a currency or maintain / abandon a peg can have tremendous impact on exchange rates. In developed country economies, Central Bank influence on the FX markets is limited to deciding the official policy rate - this has a significant bearing on the exchange rates of big economy currencies (e.g. USD, GBP, EUR). Hence, any data that has an influence on the policy rate decision must be watched carefully (e.g. data on GDP, inflation, retail sales, housing market etc).

 To Your Success

 Ryan