Foreign exchange markets are among the most exciting in the world of finance. This is where the world's various currencies are priced by speculators, traders, banks and investment funds. By some estimates, over $4 trillion a day changes hands in the foreign exchange (forex) markets. This is more than all of the world's stock and bond markets combined. Foreign exchange means the value of one country's currency against another, and that is the primary way currencies trade: in pairs.The major currencies are considered to be the U.S. dollar, the Euro, the Japanese Yen, the British Pound, the Swiss Franc and the Australian, Canadian and New Zealand dollars.
Open 24 Hours
One of the biggest differences between the forex markets and markets for other asset classes is that the forex markets are open 24 hours a day. The trading session starts when the Tokyo market opens and once Tokyo closes, London opens. London then passes the baton to New York to complete the day. Since no other markets are open 24 hours a day, no other markets offer the potential for profit (or loss) the way the forex does.
Demand Factors
One factor on demand for various currencies is tourism. That's right. Every time a traveler enters a country other than his own, he must convert his cash into the currency of the country he is entering. That creates demand.
Another way demand is created is within the forex markets themselves where speculators and traders will value another currency above another, which may lead other investors to purchase the higher valued currency.
Central banks also weigh on demand for certain currencies. For example, if the Bank of England wants to purchase a large amount of U.S. dollars, that will lower the supply and the dollar will rise as a result.
No Central Exchange
There is no central exchange or regulatory body for the forex markets. In the United States, the stock exchanges are located in New York and they regulate themselves, though they are subject to the rules and regulations of the U.S. Securities and Exchange Commission. There is no home market for the forex market and hence no regulatory body to enforce rules and regulations. The International Bank of Settlements tracks trading volume, but it is not an enforcement body.
The Largest Forex Traders
By volume, the largest players in the foreign exchange markets are Germany's Deutsche Bank, Switzerland's UBS, England's Barclays Capital, the United States' Citigroup and the Royal Bank of Scotland. The biggest trading center is London.
Other Participants
About 70 to 90 percent of forex transactions are used for investment purposes, meaning the rest are purchases by central banks as part of swaps with other central banks. Hedge funds are among the biggest speculators in the foreign exchange markets and are known for their aggressive tactics.
How Foreign Exchange Rates Are Calculated
Trade between two countries can impact how their currencies are valued as a pair. For example, if the United States has $1 million and Japan has $1 million, the dollar and the yen would be equal. However, if the United States buys $100,000 worth of goods from Japan, in theory, Japan is now wealthier and the yen would rise against the dollar.
Interest rates set by central banks also impact currency valuations. If the Federal Reserve raises interest rates, the cost of borrowing dollars rises and the dollar's value in turn increases. When the Fed lowers rates, dollars are cheaper and their value falls. And if a country's central bank decides to print more money, the value of its currency will almost always decline.
