Fundamental Analysis Chapter-II

Education - Fundamental Analysis Chapter-II

Introduction to Forex Markets


Currency trading has been known to the world for ages and can be tracked down to the Middle East and Middle Ages. Back then, international merchant bankers prepared documents called bills of exchange. These transferable third-party payments allowed flexibility and growth of currency exchange deals.

The world has changed and the modern currency trading takes place in a different way. Nowadays, the Foreign Exchange Market (FOREX) is the biggest market in the world. Since currencies were allowed to float freely against each other, currency trading experienced an immense growth in volume. Just to picture that, take a look at the following daily turnover data:

Year               Turnover
1977              $5 billion      
1987              $600 billion
1992              $1 trillion
2000              $1.5 trillion
2007              $2.7 trillion
2008              $3.4 trillion
2009              over $4.5 trillion.

Did you know that the daily turnover of currencies in 2009 is three times larger than the stocks and bonds market put together!

Forex is an Over The Counter (OTC) market which does not have a specified place of trading - i.e. "Floor" of any stock exchange. The market is made of banks, brokerage houses and other systems interconnected by computer and communication networks, mostly the Internet. The lack of a specified physical location for the FOREX market allows it to work 24 hours a day, 5 days a week. All the developed countries in the world contribute to its existence. The main centers of FOREX transactions are London, New York and Tokyo.
Major market participants groups are:

Hedgers – typically medium and large export and/or import companies or dealing other ways with foreign currencies, seeking to limit their currency risks. Due to an increase in private individual debt, individual investors can also be included in this group. Hedging techniques minimize currency risk.

Speculators – these are companies but mostly individual investors that seek to gain profits from changes in the price of derivative instruments over time.

Arbitragers – investors with significant assets that make transactions on a minimum of two markets simultaneously, using exchange rates differentials to make profits. Market inefficiencies allow to make profits from differences in financial instrument prices.

Market Makers – financial institutions (ex. Brokerage houses) that act as intermediaries in transactions between speculators and hedgers. Market makers provide liquidity of the forex markets.

The great number of participants makes FOREX the most liquid financial market in the world and practically impossible to manipulate even for central banks of the most developed countries. For this reason, traders who are able to properly predict future price movements can achieve significant profits on the market.
In conclusion, foreign exchange is a very specific market that differs from all other financial systems around the world. Those differences can summarized as follows:
-       accessibility to both financial institutions and individual traders in all major currencies.
-       guaranteed quantity and liquidity.
-       sensibility to a large and continuously changing number of factors.
-       24 hour , 5 days a week trading
-       extremely high efficiency relative to other financial markets.