INTRODUCTION
The following is a list of facts and
figures relating to the foreign exchange market. Most of the
information comes from the preliminary results of the Triennial
Central Bank Survey of Foreign Exchange and Derivatives Market
Activity conducted by the Bank for International Settlements
(BIS) in April 2004. 52 central banks and monetary authorities
participated in the survey, collecting information from approximately
1200 market participants.
STRUCTURE
- Decentralised, over-the-counter
market, also known as the 'interbank' market
- Main participants: Central Banks,
commercial and investment banks, hedge funds, pension funds,
corporations & private speculators
- The free-floating currency system
began in 1973, and was officially mandated in 1978
- Online trading began in the mid
to late 1990's
Major Markets
- The US & UK account for more
than 50% of turnover
- Major markets: London, New York,
Tokyo
- Trading activity is heaviest when
major markets overlap
- Nearly two-thirds of NY activity
occurs in the morning hours while European markets are open
Turnover by Country
CURRENCIES
The US dollar is involved in approximately
90% of all foreign exchange transactions, equivalent to over
$ 2 trillion a day.
CURRENCY PAIRS
- Majors: EUR/USD, USD/JPY, GBP/USD,
USD/CHF
- Dollar bloc: USD/CAD, AUD/USD,
NZD/USD
- Major crosses: EUR/JPY, EUR/GBP,
EUR/CHF, GBP/JPY, GBP/CHF
EXCHANGE RATES AND SPREADS
All currencies are assigned an International
Standards Organization (ISO) code abbreviation. In currency
trading, these codes are often used to express which specific
currencies make up a currency pair. For example, EUR/USD refers
to two currencies: the Euro Dollar and the US Dollar.
EXCHANGE RATE
An exchange rate is simply the ratio
of one currency valued against another. The first currency
is referred to as the base currency and the second as the
counter or quote currency. If buying, an exchange rate specifies
how much you have to pay in the counter or quote currency
to obtain one unit of the base currency. If selling, the exchange
rate specifies how much you get in the counter or quote currency
when selling one unit of the base currency.
EUR/USD
base currency/quote
currency
BID/ASK PRICE: A currency exchange rate is
typically given as a bid price and an ask price. The bid price
is always lower than the ask price. The bid price represents
what will be obtained in the quote currency when selling one
unit of the base currency. The ask price represents what has
to be paid in the quote currency to obtain one unit of the
base currency. The following EUR/USD price quote is an example
of bid/ask notation:
EUR/USD: 1.3600/ 1.3608
EXAMPLE: The first component (before the
slash) refers to the BID price (what you obtain in USD when
you sell EUR). In this example, the BID price is 1.3600. The
second component (after the slash) is used to obtain the ASK
price (what you have to pay in EUR if you buy USD). In this
example, the ASK price is 1.3608.
SPREAD: The difference
between the bid and the ask price is referred to as the spread.
In the example above, the spread is .0008 or 8 pips. Unlike
the EUR/USD, some currency pair quotes are carried out to
the 2nd decimal place (i.e. USD/JPY may be quoted at 119.42/50),
in which case 8 pips represents a difference of .08. Although
a pip may seem small, a movement of one pip in either direction
can translate into thousands of dollars in gains or losses
in the inter-bank market.
BUYING AND SELLING
All trades result in the buying of
one currency and the selling of another, simultaneously.
Buying ("going long") the
currency pair implies buying the first, base currency and
selling an equivalent amount of the second, quote currency
(to pay for the base currency). It is not necessary to own
the quote currency prior to selling, as it is sold short.
A trader buys a currency pair if he/she believes the base
currency will go up relative to the quote currency, or equivalently
that the corresponding exchange rate will go up.
Selling ("going short") the
currency pair implies selling the first, base currency, and
buying the second, quote currency. A trader sells a currency
pair if he/she believes the base currency will go down relative
to the quote currency, or equivalently, that the quote currency
will go up relative to the base currency.
An open trade or position is one in
which a trader has either bought or sold one currency pair
and has not sold or bought back an adequate amount of that
currency pair to effectively close the trade. When a trader
has an open trade or position, he/she stands to profit or
lose from fluctuations in the price of that currency pair.
SUPPLY & DEMAND FUNDAMENTALS
DIRECT
RATES: Most currencies
are traded directly against the US Dollar. The market rates
that are expressed for such currency pairs are called direct
rates. In most cases, the US Dollar is the base currency pair
whereby the quote currency is expressed as a certain number
of units per 1 US Dollar. For example, the following rate
USD/CAD=1.4500 indicates that 1 USD (US Dollars)= 1.4500 CAD
(Canadian Dollars).
INDIRECT RATES: For
some currency pairs, the US Dollar is not the base currency
but the counter or quote currency. The market rates that are
expressed for such currency pairs are called indirect rates.
This is the case with GBP (British Pound or "Cable"),
NZD (New Zealand Dollar), EUR (Eurodollar), and AUD (Australian
Dollar). For example, the following rate GBP/USD=1.5800 indicates
that 1 GBP (British Pound)= 1.5800 USD (US Dollars).
CROSS RATES: When
one currency is traded against any currency other than the
USD, the market rate for this currency pair is called a cross
rate. Cross rate is the exchange rate between two currencies
not involving the US Dollar. Although the US dollar rates
do not appear in the final cross rate, they are usually used
in the calculation and so must be known. Trading between two
non-US Dollar currencies usually occurs by first trading one
against the US Dollar and then trading the US Dollar against
the second non-US Dollar currency. There are a few non-US
Dollar currencies that are traded directly, such as GBP/EUR
or EUR/CHF.
Spot Deal / Market
A spot deal consists of a bilateral
contract between a party delivering a specified amount of
a given currency to a counter party and receiving a specified
amount of another currency in return, based on an agreed upon
exchange rate. Delivery for spot deals occurs within two business
days of the deal date, which is referred to as the settlement
date. (The settlement date for USD/CAD is one business day
after the deal date.)
CALCULATING YOUR PROFIT OR
LOSS ON A TRADE
Example:
You see that the rate for EUR/USD is 1.3552/3560 and decide
to buy 100,000 EUR. Your trade is executed at 1.3560
100,000 EUR * 1.3560 = 135600.00 USD
You bought 100,000 EUR and sold 135600.00 USD
After you trade, the market rate of
EUR/USD increases to EUR/USD = 1.3590/3598. You then sell
back 100,000 EUR at 1.3590.
100,000 EUR * 1.3590 = 135900.00 USD
You bought 100,000 EUR for 135600.00
USD and sold 100,000 EUR back for 135900.00 USD. The difference
is your profit:
135900.00 - 135600.00 = $300.00 USD
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