The currency market (also known as the foreign exchange market) is a one-stop marketplace where different currencies can be bought and sold by various participants operating in diverse jurisdictions around the globe. This market plays a very pivotal role in the conduct of international trade and the financial sector.
It serves companies and individuals by enabling them to purchase and sell goods and services denominated in foreign currencies and the smooth flow of capital. The currency markets operate relentlessly and have major participants such as large international banks, corporations, government entities, retail participants, etc.
- The currency market (also known as the foreign exchange market) is a one-stop marketplace where different currencies can be bought and sold by various participants operating in various jurisdictions globally.
- It is not a single market exchange but a network of global markets that work as per different time zones starting with the Japanese marketplace, followed by Hongkong, Singapore, India, the Middle East (Bahrain), Europe, the United Kingdom, the USA, and Canada and ending with Australia.
- In it, the buy-side has buyers of foreign currencies and forwards FX contracts. Sell-side has primary dealers in money and originators of foreign exchange contracts, such as large corporations.
- A currency market exchange involves traders, speculators, arbitrageurs, investors, banks/FI, corporations, etc. Together, they make these markets highly efficient and liquid.
How Does Currency Market Work?
A currency market is a place for trading in the currency where participants belong to various jurisdictions. Market participants enter the markets with different purposes. Together, they make the market more liquid and increase its efficiency. In addition, since the currency market timing is on a clock basis, the currency market provides the international banking system a greater opportunity to handle the current account, and capital account
transactions. As such, these markets are the driving force behind vibrant global economies.
It is important to note here that the currency market is a network of global markets that do not work simultaneously. They work as per different time zones starting with the Japanese marketplace, followed by Hongkong, Singapore, India, the Middle East (Bahrain), Europe, the United Kingdom, the USA, and Canada, and ending with Australia.
A live currency market deal with different currencies. These currencies are hugely impacted by fundamental factors such as the balance of payments formula, expected economic growth rate, fiscal policy by the government of the country, the autonomy of the Central Bank in the implementation of monetary policy, and the interest rate environment in general, which makes once currency depreciate or appreciate against other currencies.
It is an important market and plays an indispensable role in exchanging currency from one country to another. The successful integration of the world and free flow of trade is possible. The flourishing currency market enables buyers of goods and services and sellers to convert their foreign exchange receipts/payments into local currency Trading In the Currency Market. A foreign currency market involves traders, Speculators, arbitrageurs, investors, banks/FI and corporations, etc.; together, they make the currency markets highly efficient and liquid.
Trading In the Currency Market
Before trading in this market, it is necessary for a trader to gather enough information and have a clear understanding of it. However, currency market timing is 24 hours. It comprises two sides. Buy-Side has buyers of foreign currencies and forwards FX contracts. Sell-side consists of primary dealers in money and originators of foreign exchange contracts, such as large corporations.
The currencies are paired and traded, which means one currency is exchanged for another. But a very less number of currency pairs actually influence the market.
The price of each currency changes depending on the economic, political, and financial conditions of the countries. The market is closed from the evening of Friday to the evening of Sunday. Since during trading hours, the important currencies are mainly traded, they are the ones with the highest trading volumes.
Due to the pairing system, if the traders buy one currency, they have to sell another one. They are quoted as pips or percentages in points.
In a live currency market trading is done in lot size which changes as per the currency. Beginners or retailers try to trade in the smallest lot so that in case of loss, it is easily manageable.
Let us understand the role of foreign exchange market
with the help of a few examples: –
Nomura, the Japanese Investment Bank, has recently concluded a deal and expects 20 million euros after three months. However, after three months, the price of Yen/Euro can move in any direction and, as a result, has Yen/Euro exchange risk. To overcome this risk, Nomura entered the market and entered into a forward currency contract to sell 20 million euros at the end of three months at a predetermined price in terms of Yen. By entering into such a contract facilitated by the market, Nomura can eliminate its foreign exchange risk associated with the transaction.
Xylo, a trading firm, believes that the economic crisis in India will impact its fiscal deficit. Therefore, it will have a widespread impact on the local currency against the dollar and expect the rupee to depreciate heavily against the dollar and build into speculative positions by taking the buy-side place in USD/INR predicting local currency depreciation INR against the USD and making profits for the firm.
The above is an example of how currency market exchange speculate about exchange rate fluctuation. Investors, companies, and financial institutions such as banks and investment funds often enter it.
Some of the advantages are as follows: –
- They bring in money liquidity and enable huge trade volumes to happen, which provides ample employment and profits for various businesses.
- They are so colossal that no single entity can impact them, and a seamless flow of information makes the markets highly efficient.
- It is necessary to make foreign investments as it allows the currency to be converted into local currency for investment in the business of the country in question.
- It enables the different currencies to be priced concerning other money. A usually stronger currency is characterized by strengthening the economy.
- The currency market exchange enables multinational corporations that engage in cross-border transactions to hedge the risk of their future receipts and payments denominated in foreign currencies.
Some of the disadvantages are as follows: –
- They are controlled by the respective governments of the local currency, and central banks of regional countries engage in forex transactions to affect exchange rates per government policy resulting in violent exchange rate movements. For instance, the Central Bank of any country can decrease the supply of its local currency and increase its price in other currencies by selling foreign reserves such as a large amount of gold and foreign currencies.
- They increase various risks, out of which the most prominent is counterparty risk as the currency market is international, and the failure of one counterparty can impact many other counterparties.
- Due to the sheer size of currency markets, they are largely unregulated despite any number of measures being taken by the local government of each country.
- They are high-leverage trades and big institutions. Hedge funds bet heavily in these markets, prone to failure and closure if their bets blow.