Forex Overview

1. Introduction: What is Forex?

The Forex market (Foreign exchange Market) is the market in which currencies are bought and sold. For example, a market participant is able to receive Australian dollars by paying a specified amount of US dollars. In effect the trader has bought Australian dollars and sold US dollars.

The prices of currencies that are set in the market are determined by the amounts that buyers and sellers are willing to pay. For example if there are more participants in the market that want to buy Australian dollars, than want to sell Australian dollars at a specific price then the price of the Australian dollar will rise until it reaches a price where there is an equal amount of participants willing to buy and sell at the same price.

Profits can be made in the Forex market due to movements in the prices of currencies. The idea is; if you were to buy a currency at a lower price than you sell it for, you have made a profit equal to the difference in the two prices. This is made possible by the simple fact that the price of the currency has changed. If the prices of currencies are constantly changing by large amounts (the market is volatile), there is greater potential for higher profits to be made. The Forex market is recognized as one of the most volatile markets in the world.


2. History of Forex

Prior to 1971, an agreement known as the Bretton Woods Agreement stopped speculation in the currency markets. It was set up in 1945 with the intention of stabilizing international currencies and preventing money fleeing across nations. This agreement fixed all national currencies against the dollar and set the dollar at a rate of $35 per ounce of gold. Prior to this agreement the gold exchange standard had been used since 1876. The gold standard used gold to back each currency and thus prevented kings and rulers from arbitrarily debasing money and triggering inflation. Institutions like the Federal Reserve System of the United States have this kind of power.

The gold exchange standard had its own problems however. As an economy grew it would import goods from overseas until it ran its gold reserves down. As a result the country's money supply would shrink resulting in interest rates rising and a slowing of economic activity to the extent that a recession would occur.

Eventually the recession would cause prices of goods to fall so low that they appeared attractive to other nations. This in turn led to an inflow of gold back into the economy and the resulting increase in money supply saw interest rates fall and the economy strengthen. These boom-bust patterns prevailed throughout the world during the gold exchange standard years until the outbreak of World War 1 which interrupted the free flow of trade and thus the movement of gold.

After the war the Bretton Woods Agreement was established, where participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar. A rate was also used to value the dollar in relation to gold. Countries were prohibited from devaluing their currency to improve their trade position by more than 10%. Following World War II international trade expanded rapidly due to post-war construction and this resulted in massive movements of capital. This destabilized the foreign exchange rates that had been set-up by the Bretton Woods Agreement.

The agreement was finally abandoned in 1971, and the US dollar was no longer convertible to gold. By 1973, currencies of the major industrialized nations became more freely floating, controlled mainly by the forces of supply and demand. Prices were set, with volumes, speed and price volatility all increasing during the 1970's. This led to new financial instruments, market deregulation and open trade. It also led to a rise in the power of speculators.

In the 1980's the movement of money across borders accelerated with the advent of computers and the market became a continuum, trading through the Asian, European and American time zones. Large banks created dealing rooms where hundreds of millions of dollars, pounds, euros and yen were exchanged in a matter on minutes. Today electronic brokers trade daily in the forex market, in London for example, single trades for tens of millions of dollars are priced in seconds. The market has changed dramatically with most international financial transactions being carried out not to buy and sell goods but to speculate on the market with the aim of most dealers to make money out of money.
London has grown to become the world's leading international financial center and is the world's largest forex market. This arose not only due to its location, operating during the Asian and American markets, but also due to the creation of the Eurodollar market. The Eurodollar market was created during the 1950's when Russia's oil revenue, all in US dollars, was deposited outside the US in fear of being frozen by US authorities. This created a large pool of US dollars that were outside the control of the US. These vast cash reserves were very attractive to foreign investors as they had far less regulations and offered higher yields.

Today London continues to grow as more and more American and European banks come to the city to establish their regional headquarters. The sizes dealt with in these markets are huge and the smaller banks, commercial hedgers and private investors hardly ever have direct access to this liquid and competitive market, either because they fail to meet credit criteria or because their transaction sizes are too small. But today market makers are allowed to break down the large inter-bank units and offer small traders the opportunity to buy or sell any number of these smaller units (lots).


3. The History of Retail Forex

Retail trading, is more structured than the Forex market as a whole. While Forex has been traded since the beginning of financial markets, modern retail trading has only been around since about 1996. Prior to this time, retail investors were limited in their options for entering the Forex market. They could create multiple bank accounts, each one denominated in a different currency, and transfer funds from one account to another in order to profit from fluctuating exchange rate. This was troublesome, however, because the transaction costs incurred were large due to the small quantity of funds being converted relative to the size of the market. This transaction type was at the very bottom of the Forex pyramid.

By 1996, new market makers took advantage of developments in web-based technology that made retail Forex trading practical. The new companies felt that there was enough liquidity in the Forex market, and eventually within their own customer base, to guarantee markets under all but the most unusual market conditions. These companies also created online trading platforms that provided a quick and easy way for individuals to buy and sell on the Forex Spot market. In addition, the companies realized that by pooling many retail traders together, they had the size to enter the upper echelons of the Forex market, which reduced the size of the spread. As the business grew, the market makers were given better prices, which they then passed on to the customer.


4. Forex Market Participants

Central Banks
A Central Bank will intervene to buy or sell currencies if they believe it is substantially under or overvalued and that it is having a negative effect on the economy. The national central banks play a key role in the foreign exchange markets as many central banks have very substantial foreign exchange reserves, thus their intervention power is significant

Commercial Banks
Banks are licensed deposit taking institutions; they also support a variety of other services including foreign exchange. These banks will trade currencies among themselves as part of the system of balancing accounts. While exchange rates for their largest customers are extremely competitive, small and medium sized enterprises and individuals will typically pay a large premium when transacting foreign exchange with their local branch. The interbank market caters for both the majority of commercial turnover as well as enormous amounts of speculative trading every day. It is not uncommon for a large bank to trade billions of dollars on a daily basis.

Non Banking Corporations
This group comprises of companies who are involved in the 'goods' market, conducting international transactions for the purchase or sale of merchandise. Exporters are made up of a diverse range of companies exporting goods and services. Generally, exporters have a positive impact on the value of a country's currency. Importers use the foreign exchange markets to purchase foreign currency to make payments for the goods and services they have bought in other countries. They generally have a negative impact on the value of a country's currency. Their trade sizes are most often inconsequential to affect immediate moves in the market, given the large volume traded daily on the Forex market. However since a major key factor for long term trend of currency movements is the balance of trade, if taken as a whole the capital flows arising from these corporations end up having a significant impact.

Hedge Funds
Their influence has increased significantly in the last few years thanks to the overall growth in their industry and abundance of funds at their disposal; however the net effect of this group depends on the investment decisions they make. With the growth of the FX industry they have been, where possible, investing heavily in foreign securities and other foreign financial instruments.

Brokers
They can classified into Interbank and Client brokers with the influence of the former declining in the last few years due o the shift of businesses to electronic trading systems. The advent of online pricing systems has revolutionized the operational capabilities of this market and changed the traditional role of brokers. But even in the past, most banks were unable to service the needs of small to medium sized organizations as well as commercial & private clients with large corporations their main targeted market. Thus keeping in mind the client's needs ability to invest a certain amount of minimum margin and still be able to trade on competitive spreads led to the advent of Online Broking Companies and ForexCT.com belongs to this group.

Investors/Speculators
Given that the Forex market has high liquidity, a large amount of leverage and the 24/7 operational nature of the market, it has been an attractive playing field for speculators. The service provided by speculators to a market is primarily that by risking their own capital in the hope of profit, they add liquidity to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs


5. Major Currencies

US Dollar
$USAlso referred to as the dollar, greenback and buck.
The US Dollar was adopted by the Congress of the Confederation of the United States on July 6, 1785 and is the most used in international transactions. Several countries use the U.S. dollar as their official currency, and many others allow it to be used in a de facto capacity.

In 1995, over US$380 billion were in circulation, of which two-thirds was outside the United States. By 2005, those figures had doubled to nearly $760 billion with an estimated half to two-thirds being held overseas, which is an annual growth of about 7.6%. However, as of December 2006, the dollar was surpassed by the euro in terms of combined value of cash in circulation. The value of euro notes in circulation has risen to more than € 610 billion, equivalent to US$800 billion at the exchange rates at this time.
The U.S. dollar uses the decimal system, consisting of 100 (equal) cents (symbol ¢).

The Euro - €
The euro (currency sign: €; banking code: EUR) is the official currency of the European states of Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia and Spain - also known as the Eurozone - and is the single currency for more than 317 million people in Europe.
Including areas using currencies pegged to the euro, the euro affects more than 480 million people worldwide, with more than €610 billion in circulation as of December 2006.

While all EU member states are eligible to join if they comply with certain monetary requirements, the euro is not used in all of the European Union as not all EU members have adopted the currency. All nations which have recently joined the EU are pledged to adopt the euro in due course, but the United Kingdom and Denmark are under no such obligation. Several small European states (The Vatican, Monaco and San Marino), although not EU members, have adopted the euro due to currency unions with member states. Andorra, Montenegro and Kosovo have adopted the euro unilaterally.

The Yen - ¥
The yen or (Japanese yen) is the currency of Japan. It is also widely used as a reserve currency after the United States dollar and euro.

The Great British Pound - £
Other Names - Sterling, Cable and the Pound (symbol: £; ISO code: GBP), divided into 100 pence, is the official currency of the United Kingdom and the Crown Dependencies. The slang term "quid" is very common in the UK.
The official full name pound sterling (plural: pounds sterling) is used mainly in formal contexts and also when it is necessary to distinguish the currency used within the United Kingdom from others that have the same name. The Sterling is the third most traded currency in the world, after the US dollar and the euro.


The Swiss Franc - CHF
The franc (ISO 4217: CHF or 756) is the currency and legal tender of Switzerland and Liechtenstein. The Italian exclave Campione d'Italia and the German exclave Büsingen also use the Swiss franc. Franc banknotes are issued by the central bank of Switzerland, the Swiss National Bank, while coins are issued by the federal mint, Swissmint.

The Swiss franc is the only version of the franc still issued in Europe. Its name in the four official languages of Switzerland is Franken (German), franc (French and Rhaeto-Romanic), and franco (Italian). The smaller denomination, which is worth a hundredth of a franc, is called Rappen (Rp.) in German, centime (c.) in French, centesimo (ct.) in Italian and rap (rp.) in Rhaeto-Romanic. Users of the currency commonly write CHF (the ISO code), though SFr. is still common. SwF has been used in some publications but is not an official abbreviation.

The current franc was introduced in 1850 at par with the French franc. It replaced the different currencies of the Swiss cantons, some of which had been using a franc (divided into 10 batzen and 100 rappen) which was worth 1½ French francs.
In 1865, France, Belgium, Italy, and Switzerland formed the Latin Monetary Union where they agreed to change their national currencies to a standard of 4.5 grams of silver or 0.290322 grams of gold. Even after the monetary union faded away in the 1920s and officially ended in 1927, the Swiss franc remained on that standard until 1967.

As of November 30, 2006, the Swiss franc was worth US$ 0.826729 or € 0.628625. Since mid-2003, its exchange rate with the Euro has been stable at a value of about 1.55 CHF per Euro, so that the Swiss Franc has risen and fallen in tandem with the Euro against the U.S. dollar and other currencies.

The Swiss franc has historically been considered a safe haven currency with virtually zero inflation and a legal requirement that a minimum 40% is backed by gold reserves. However this link to gold, which dates from the 1920s, was terminated on 1 May 2000 following an amendment to the Swiss Constitution. The Swiss franc has suffered devaluation only once, on 27 September 1936 during the Great Depression, when the currency was devalued by 30% following the devaluations of the British pound, U.S. dollar and French franc.


The Australian Dollar
The Australian dollar (currency code AUD) has been, since 14 February 1966, the currency of the Commonwealth of Australia, including Christmas Island, Cocos (Keeling) Islands, and Norfolk Island, as well as the independent Pacific Island states of Kiribati, Nauru and Tuvalu. It is normally abbreviated with the dollar sign $. Alternatively A$ or $A, $AU or AU$ is used to distinguish it from other dollar-denominated currencies.

It is sometimes affectionately called the "Aussie battler"; during a low period (relative to the U.S. dollar) around 2001 and 2002 the currency was sometimes locally called the "Pacific Peso". It is divided into 100 cents.

The Australian dollar is currently the sixth-most-traded currency in world foreign exchange markets (behind the U.S. dollar, the euro, the yen, the Pound sterling, and the Swiss franc), accounting for approximately 4-5% of worldwide foreign exchange transactions. The Australian dollar is popular with currency traders due to the relative lack of government intervention in the foreign exchange market, the general stability of the economy and government as well as the prevailing view that it offers diversification benefits in a portfolio containing the major world currencies (especially because of its greater exposure to Asian economies and the commodities cycle).

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