In the 21st century, the currency market is the largest financial market in the world. Also called the “interbank market”, it used to be the place where only big institutional players exchanged currencies.
Since the personal computer (PC) and the internet, a new class of market participants has appeared: the retail traders.
Retail traders are individuals that want to invest in the currency market. The currency market (also known as Forex or FX) attracts many retail traders who speculate on the value of different currencies. Almost every country in the world has its own currency. Moreover, that currency reflects the strength of the economy and the monetary policy set by the central banks.
Some economies are in a recession, others are in an expansion, and others are stagnant. Hence, the value of their currencies fluctuates. The place to see all this action is the currency market. Nowadays, almost five trillion dollars exchange hands every day. From retail traders to institutional investors, it is a place where transactions take place at the speed of light, and where different market players have different interests.
Why Do Currencies Move?
With international trade flourishing, the global economy is experiencing increased cross-border economic activity – which sometimes requires payments in local currencies. The sum of all payments made in a currency influences the demand for a currency. Higher demand for a country’s goods leads to a higher demand for its currency. As a result, the central bank may notice the increase in economic activity and may decide to hike the interest rates. Hence, the value of money increases, with the currency gaining, or appreciating, against other currencies.
Currencies usually move because of the economic activity in a country/region. However, sometimes political decisions or elections move the currency market too. Retail traders pay a broker’s fee or commission to speculate on a currency, or currency pair’s, and buy or sell accordingly. They use various tools to decide if the currency, or currency pair, will rise or fall. Currency trading uses leverage; otherwise, very few traders could afford to access the interbank market. Typically, the leverage is associated with the risk in a trading account: the higher the leverage, the higher the risk.
Since the currency market was first introduced to traders, it created the possibility of diversifying individual portfolios. Traders can invest in a different currency or simply speculate on the short, medium, or long-term prospects of a different economy and its currency.
The U.S. Dollar is the world’s reserve currency. Effectively, this means most foreign nations keep most of their excess reserves in dollars. Moreover, commodities mostly trade in dollars, and the American dollar is the foundation of most international loans and trade. For this reason, when the dollar appreciates or depreciates, it moves the entire currency market. And, not only; as the current financial system is interdependent, other markets will react to sudden changes in the dollar’s value.
When trading currencies, everything happens fast. One’s target can be reached in seconds, unfortunately, losses can also occur in seconds. Traders see the large potential in trading currencies; this is one of the main reasons they’re attracted to this market. However, if the market is ranging and depending on the currency traded and the degree of the move expected, it may take quite some time until a significant movement occurs.
- The PC and the internet gave investors remote access to interbank markets.
- Investors buy and sell currencies/currency pairs against a fee or commission.
- The U.S. Dollar is the world’s reserve currency.
- Economic activity drives the pace of international monetary transactions.
- Foreign exchange is one of the most volatile markets in the world.