The Foreign Exchange ~ Forex ~ Market And The Two Main Purposes Of Trade - Part 1

The Foreign Exchange market is the largest financial market in the world and spans the globe.  Known also as the Forex market or FX market, the market is 24 hour in operation and is not limited to single exchange locations with in countries but is conducted where ever one currency is exchanged for another in the process of doing business.

Traditionally, the trade was primarily conducted at banks and special exchange bureaus, but today it can be literally anywhere via ATMs, hotel and from your own PC or laptop. Traders can be huge multi-national corporations, small exporters, banks, governments etc., or you. When you buy an item over the internet in another currency using your credit card or if you are on holidays and want some quick local currency cash from an ATM, you are  setting up and will engage in a forex deal. You will sell/buy, a currency at a rate set by the banking institutions involved and as determined by the market. Most small and intermediate deals are done directly using a retail bank.  When you take your cash, your bank calculates an exchange rate value in your home currency for the amount you have withdrawn and deducts that from your account.  Your bank will probably charge you a currency conversion transaction fee and the exchange rate that it sets that day for the currency you want.  The bank sets a buy rate and a sell rate, two prices which are slightly different and which enable the bank to profit from your small deal by selling you the currency you want at a slightly higher rate of exchange compared with the better rate they will receive when they offset your deal via bulk trades in the market that their dealing room will do.  So they make a profit on this price difference between the buy and sell price they set for the retail customer versus the better buy and sell price they can get as a heavy weight in the market.

The difference between the buy price and the sell price with a currency pair is called ‘the spread'.  When people shop for rates they are looking for a smaller, tighter spread difference which means a better rate of exchange and if you shop around you will find quite a bit of small variation in the spread, sometimes between retail banks. Third party exchange bureaus and hotels have to offset your trade with a bank and  the bank does so in turn using the larger bulk market, so the non-bank bureau's spread has to be greater. For example, this gives them the chance to off-load the physical currency you have sold them in exchange for the local, at a small profit to a banking institution.  Forex exchange booths at airports usually have the larger spreads in the retail market which means a poorer exchange deal for you, less dollars in the currency you are exchanging for, and so the higher cost of an on the spot last minute convenience when you are rushing for a flight.

Huge amounts of trade from so many sources and countries makes for a volatile and active market that is good for the speculator and should, as a measure reflect the changing economic performance of one country's economy in relation to another country's economy. The business person or consumer who is just looking for the best rate and most secure way to pay in a currency exchange situation can make use of certain tools available to select a rate in the market that they feel serves them best and then to  secure that rate over a given time period against further fluctuation. This then means that a business can execute the transaction in the future without finding that they have been adversely affected by a value change before the transaction has been finalized.  An example would be a small business looking for a stable, set forward, exchange value  when ordering a machine that will be delivered in six months time. It would be great if the currency they pay in for the machine goes down in value, meaning the machine costs less, but what if the currency were to go up?  Business relies on budgets and predictable outcomes and so it is usually unacceptable to leave a deal exposed to the currency market.

We can see that both types of trade use the market to their advantage in different ways for different purposes. Speculation traders seek to make profit yielding trades in the market from speculation on value change. They can do this using a broker, self operated manual or semi automated forex trading, or a forex robot trading system. Though nearly forex trading for profit was once the domain of brokerage houses, the internet has revolutionized forex trading making easy forex platforms and automated trading methods available to almost anyone.

Businesses  and corporations engaging in inter-country business seek to secure a locked in and stable rate to preserve profit margins and budget forecasts. Businesses also now use the internet to quickly and easily arrange and manage forex trades.

In part 2 we will continue to look with more detail at the two primary but different reasons for trading forex.

Thanks for reading and see you again for the next article.

Eric Bray

Trained as a foreign exchange dealer in the 1980's, Eric worked in Sydney as a professional forex broker.  Do you have a question about forex trading? Ask Eric at http://www.easyforexrobottrading.com. The author grants full reprint rights to this article. You may reprint and electronically distribute this article so long as its contents remain unchanged and the author's byline remains in place.