Introduction to the Financial Markets

6 Lessons
6 Hours

Introduction to Forex

Welcome to Introduction to Forex! In this video, you will learn the history of the foreign exchange market, the market structure, the market participants, and the various Forex pairs.

History of the Foreign Exchange Market

Way back in 1944 in Bretton Woods, NH, USA, 44 of the world’s leading nations created a new international monetary system that became known as The Bretton Woods system. According to this new system, countries will tie their currencies to the United States Dollar – convertible to gold at $35 per ounce. Central banks would buy and sell their country’s currency in order to stabilize it within 1% of the pegged level to gold or to the dollar.

In 1971, the United States abandoned the fixed value of the dollar and allowed it to float, in other words, fluctuate, against other currencies. By 1973, all the nations participating in the Bretton Woods system agreed to allow the exchange rates to float. Today, most currencies are freely floating, and their price is determined based on the demand and supply of each currency.

The Forex Market Today

The foreign exchange (Forex) market is where currencies are traded or exchanged for one another. It is the world’s largest financial market in terms of volume trade and the average daily turnover is continuously growing.

Starting with 1.7 trillion dollars in 1998, the daily volume increased to 2.2 trillion in 2005. In 2007, it reached 3.5 trillion. By 2011, the average daily turnover was 4 trillion US dollars. From 2015 onwards, it has surpassed 5 trillion dollars turnover per day.

Trading in London accounts for 37% of the total daily turnover, making it by far the most important global center for foreign exchange trading. Singapore, Hong Kong and Tokyo have 22% of daily turnover. New York has 19% of daily turnover, Europe has 8% of daily turnover, Switzerland & Australia have 2% of daily turnover each, leaving 10% to the rest of the world.

The Forex Market is a Global Market

The foreign exchange market is a global market. It has no physical location and operates 24 hours a day, five days a week Monday to Friday, all over the globe. As one major Forex market closes, another one opens. According to GMT, for instance, Forex trading hours move around the world like this: Trading starts on Sunday night at 22:00 GMT in Sydney, Tokyo joins Sydney 2 hours later and by the time Tokyo closes at 09:00 GMT, London has already opened at 08:00 GMT. At 13:00 New York opens, and we have both London and New York open until London closes at 16:00, which is the most liquid period of the day with the highest volume. When London closes, trading continues in New York until 22:00 when it closes, and Sydney opens, and the cycle starts again until Friday night.

Market

Open (GMT)

Close (GMT)

Sydney

22:00

07:00

Tokyo

00:00

09:00

London

08:00

16:00**

New York

13:00

22:00

**16:00 is the most liquid period of the day with the highest volume

This global market has 3 levels of participants. The first level is called the Interbank Market. It is where the biggest banks exchange currencies with each other. Even though it only has a few members, most of the 5 trillion a day volume ends up here. The second level is the big Forex brokers that have direct access to the interbank market to trade bulk amounts from their clients or smaller brokers. The third level is small Forex brokers and retail Forex traders - most retail traders can’t access the interbank market directly, so they need brokers in order to trade Forex.

Forex Market Participants

The main Forex market participants can be divided to 4 distinct categories: (1) central banks and federal governments, (2) commercial banks and money transfer-and-remittance companies, (3) international and commercial companies, and (4) the speculators.

The most influential participants in the Forex market are the central banks and federal governments, with their major task of maintaining foreign reserve volumes and adjusting monetary policy in order to meet certain economic goals. Commercial banks and money transfer-and-remittance companies are among the largest participants in this market as they conduct all day to day operations on behalf of their clients. International and commercial companies are also involved the Forex market. They are usually involved in selling businesses to international clients and buying from international suppliers. In doing these, they will often employ hedging strategies to reduce or completely eliminate the foreign exchange risk. Last but not least are the speculators, who attempt to make money by taking advantage of fluctuating exchange-rate levels. Speculators can be large traders such as hedge funds and small traders just like you and me.

Forex Trading

Trading in the foreign exchange market is always done through pairs. In order to buy a quantity of a one currency, first you need to sell its equivalent quantity of another currency. So to buy Euros (EUR) for example, you have to sell first the equivalent in U.S. Dollars (USD). The first currency in the pair is called the base currency and the second currency in the pair is called the quote currency.

Let's say, that the market price in EUR/USD is 1.1300. To buy 1 Euro, which is the base currency, you must give 1.13 US Dollars, which is the quote currency. In other words, you pay 1.13 US Dollar for every 1 Euro you get.

Forex Pairs

Majors

The 7 most traded pairs of currencies in the world are called the majors. Majors have the US dollar as one of the currencies in the pair, and they are usually referred to with their nickname.

Pair

Currencies

Nickname

EUR/USD

Euro against the US Dollar

Euro

USD/JPY

US Dollar against the Japanese Yen

Dollar Yen

GBP/USD

British Pound against the US Dollar

Cable or Sterling

USD/CHF

US Dollar against the Swiss Franc

Swissy

USD/CAD

US Dollar against the Canadian Dollar

Loonie

AUD/USD

Australian Dollar against the US Dollar

Aussie Dollar

NZD/USD

New Zealand Dollar against the US Dollar

Kiwi

The major Forex pairs represent 80% of the daily traded volume and have the following features: (1) they are very liquid as they are heavily traded, (2) they are not very volatile compared to other pairs, (3) they are very hard, if not impossible, to manipulate, and (4) they are characterized by very low transaction costs as a result of their high liquidity. Beginner Forex traders are strongly advised to trade only the major pairs.

Crosses

Currency pairs that do not involve the US Dollar are called crosses, because usually, before we trade these pairs, we have to trade first a pair which includes the US Dollar.

For example, let’s say you have Euro and you want to buy Yen. You must first exchange your Euro to US Dollar using the EUR/USD exchange rate, and then convert the US Dollar you got into Japanese Yen using the USD/JPY exchange rate. Or you cross out the US Dollar from the equation and you get directly the EUR/JPY rate, hence the name crosses. Listed below are the most actively traded cross pairs.

Pair

Currencies

EUR/JPY

Euro against the Japanese Yen

NZD/JPY

New Zealand Dollar against the Japanese Yen

GBP/JPY

British Pound against the Japanese Yen

EUR/GBP

Euro against the British Pound

EUR/CHF

Euro against the Swiss Franc

AUD/JPY

Australian Dollar against the Japanese Yen

NZD/AUD

New Zealand Dollar against the Australian Dollar

Crosses are considered slightly riskier than major pairs and are known for the following features: (1) they are less liquid as they are not heavily traded, (2) they are more volatile compared to the majors, (3) they are slightly easier to manipulate than majors due to the reduced volume, and (4) they are characterized by low to medium transaction costs.

Exotics

Currency pairs with at least one currency being the currency of an emerging economy, are called Exotics. Some of them are listed below.

Pair

Currencies

EUR/TRY

Euro against the Turkish Lira

USD/TRY

US Dollar against the Turkish Lira

USD/MXN

US Dollar against the Mexican Peso

USD/ZAR

US Dollar against the South African Rand

USD/SGD

US Dollar against the Singapore Dollar

USD/DKK

US Dollar against the Danish Krone

USD/HKD

USD Dollar against the Hong Kong Dollar

The exotic pairs are not traded as often as the majors or crosses; so the cost of trading them can be high and they have the following features: (1) they are very illiquid, (2) they are very volatile pairs because of their sensitivity to sudden political & financial developments, (3) they are susceptible to manipulation due to very low volumes, and (4) they have very high transaction costs. Only very experienced Forex traders are advised to trade exotics.

Recap!

Bretton Woods System

An international monetary system that tied its currency to the US Dollar

Float

Currency’s price is determined based on the demand and supply of each currency

Interbank market

Where the biggest banks exchange currencies with each other

Big Forex brokers

Those that have direct access to the interbank market to trade bulk amounts from their clients or smaller brokers

Small Forex brokers

Those that do not have direct access to the interbank market

Central banks (as a Forex market participant)

Along with the federal government, maintains foreign reserve volumes and adjusts monetary policy in order to meet certain economic goals

Commercial banks and money-transfer-and-remittance centres (as a Forex market participant)

One of the largest participants in the Forex market as they conduct all day to day operations on behalf of their clients

International and commercial companies (as a Forex market participant)

Usually involved in selling businesses to international clients and buying from international suppliers. They often employ hedging strategies to reduce or completely eliminate the foreign exchange risk.

Speculators

May refer to large traders such as hedge funds and small traders.

Base currency

First currency in the pair. The currency you are buying.

Quote currency

Second currency in the pair. The one that you are selling in exchange for the base currency.

Major pairs or Majors

The 7 most traded currency pairs in the world.

Cross pairs or Crosses

Currency pairs that do not involve the US Dollar. Before they can be traded, one currency needs to be traded against the US Dollar.

Exotic pairs or Exotics

Currency pairs with at least one currency being the currency of an emerging economy.

In our next video, we will talk about CFDs. Thank you for watching!