Foreign Exchange Market

Overview

The Foreign Exchange Market (also known as forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of buying, selling and exchanging currencies at current or determined prices.

A bustling trading floor with screens displaying various currency exchange rates.

History

The foreign exchange market as we know it today started evolving during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

Market Participants

Participants in the foreign exchange market include:

Function and Purpose

The primary function of the foreign exchange market is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a business in the United States to import goods from the European Union member states, and pay Euros, even though its income is in United States dollars.

A person using a calculator and a list of currency exchange rates to convert one currency to another.

Trading Characteristics

Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the "interbank market". Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions.

Financial Instruments

Financial instruments in the foreign exchange market include:

Determinants of Exchange Rates

The following theories explain the fluctuations in exchange rates in a floating exchange rate regime:

A digital display of fluctuating currency exchange rates.

Speculation and Controversy

Currency speculation is considered a highly suspect activity in many countries. While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to many economists, it benefits mostly the individual investor, and contributes to volatility in the foreign exchange market.