The foreign exchange market allows for the trading of one country's currency for another. It is a decentralized global market with trillions traded daily between banks, brokers, institutions and individuals. Currencies are quoted in pairs and can be traded in micro, mini and standard lots. The largest trading centers are London, New York, Singapore and Tokyo, allowing trading 24/5. Traders speculate on currency movements hoping to profit from rises or falls.

1. 1 What Is Foreign Exchange (Forex)?
Foreign Exchange (forex or FX) is the trading of one currency for another. For example, one can
swap the U.S. dollar for the euro. Foreign exchange transactions can take place on the foreign
exchange market, also known as the Forex Market.
The forex market is the largest, most liquid market in the world, with trillions of dollars changing
hands every day. There is no centralized location, rather the forex market is an electronic
network of banks, brokers, institutions, and individual traders (mostly trading through brokers or
banks).
KEY TAKEAWAYS
 Foreign Exchange (forex or FX) is a global market for exchanging national currencies
with one another.
 Foreign exchange venues comprise the largest securities market in the world by nominal
value, with trillions of dollars changing hands each day.
 Foreign exchange trading utilizes currency pairs, priced in terms of one versus the other.
 Forwards and futures are another way to participate in the forex market.
2 How Does Foreign Exchange Work?
The market determines the value, also known as an exchange rate, of the majority of currencies.
Foreign exchange can be as simple as changing one currency for another at a local bank. It can
also involve trading currency on the foreign exchange market. For example, a trader is betting a
central bank will ease or tighten monetary policy and that one currency will strengthen versus the
other.
When trading currencies, they are listed in pairs, such as USD/CAD, EUR/USD, or USD/JPY.
These represent the U.S. dollar (USD) versus the Canadian dollar (CAD), the Euro (EUR) versus
the USD and the USD versus the Japanese Yen (JPY).
There will also be a price associated with each pair, such as 1.2569. If this price was associated
with the USD/CAD pair it means that it costs 1.2569 CAD to buy one USD. If the price increases
to 1.3336, then it now costs 1.3336 CAD to buy one USD. The USD has increased in value
(CAD decrease) because it now costs more CAD to buy one USD.
In the forex market currencies trade in lots, called micro, mini, and standard lots. A micro lot is
1000 worth of a given currency, a mini lot is 10,000, and a standard lot is 100,000. This is
different than when you go to a bank and want $450 exchanged for your trip. When trading in
the electronic forex market, trades take place in set blocks of currency, but you can trade as
many blocks as you like. For example, you can trade seven micro lots (7,000) or three mini lots
(30,000) or 75 standard lots (7,500,000), for example.
3 Size of the Foreign Exchange Market
The foreign exchange market is unique for several reasons, mainly because of its size. Trading
volume in the forex market is generally very large. As an example, trading in foreign exchange
markets averaged $5.1 trillion per day in April 2016, according to the Bank for International

2. Settlements, which is owned by 60 central banks and is used to work in monetary and financial
responsibility.
The largest trading centers are London, New York, Singapore, and Tokyo.
4 Trading in the Foreign Exchange Market
The market is open 24 hours a day, five days a week across major financial centers across the
globe. This means that you can buy or sell currencies at any time during the day.
The foreign exchange market isn't exactly a one-stop shop. There are a whole variety of different
avenues that an investor can go through in order to execute forex trades. You can go through
different dealers or through different financial centers which use a host of electronic networks.
From a historical standpoint, foreign exchange was once a concept for governments, large
companies, and hedge funds. But in today's world, trading currencies is as easy as a click of a
mouse—accessibility is not an issue, which means anyone can do it. In fact, many investment
firms offer the chance for individuals to open accounts and to trade currencies however and
whenever they choose.
When you're making trades in the forex market, you're basically buying or selling the currency of
a particular country. But there's no physical exchange of money from one hand to another. That's
contrary to what happens at a foreign exchange kiosk—think of a tourist visiting Times Square
in New York City from Japan. He may be converting his (physical) yen to actual U.S. dollar
cash (and may be charged a commission fee to do so) so he can spend his money while he's
traveling.
But in the world of electronic markets, traders are usually taking a position in a specific
currency, with the hope that there will be some upward movement and strength in the currency
that they're buying (or weakness if they're selling) so they can make a profit.
5 Differences in the Forex Markets
There are some fundamental differences between foreign exchange and other markets. First of
all, there are fewer rules, which means investors aren't held to as strict standards or regulations as
those in the stock, futures or options markets. That means there are no clearing houses and no
central bodies that oversee the forex market.
Second, since trades don't take place on a traditional exchange, you won't find the same fees
or commissions that you would on another market. Next, there's no cut-off as to when you can
and cannot trade. Because the market is open 24 hours a day, you can trade at any time of day.
Finally, because it's such a liquid market, you can get in and out whenever you want and you can
buy as much currency as you can afford.
6 The Spot Market
Spot for most currencies is two business days; the major exception is the U.S. dollar versus the
Canadian dollar, which settles on the next business day. Other pairs settle in two business days.
During periods that have multiple holidays, such as Easter or Christmas, spot transactions can

3. take as long as six days to settle. The price is established on the trade date, but money is
exchanged on the value date.
The U.S. dollar is the most actively traded currency. The most common pairs are the USD versus
the euro, Japanese yen, British pound and Swiss franc. Trading pairs that do not include the
dollar are referred to as crosses. The most common crosses are the euro versus the pound and
yen.
The spot market can be very volatile. Movement in the short term is dominated by technical
trading, which focuses on direction and speed of movement. People who focus on technicals are
often referred to as chartists. Long-term currency moves are driven by fundamental factors such
as relative interest rates and economic growth.
7 The Forward Market
A forward trade is any trade that settles further in the future than spot. The forward price is a
combination of the spot rate plus or minus forward points that represent the interest rate
differential between the two currencies. Most have a maturity less than a year in the future but
longer is possible. Like with a spot, the price is set on the transaction date, but money is
exchanged on the maturity date.
A forward contract is tailor-made to the requirements of the counterparties. They can be for any
amount and settle on any date that is not a weekend or holiday in one of the countries.
8 The Futures Market
A futures transaction is similar to a forward in that it settles later than a spot deal, but is for
standard size and settlement date and is traded on a commodities market. The exchange acts as
the counterparty.
9 Example of Foreign Exchange
A trader thinks that the European Central Bank (ECB) will be easing its monetary policy in the
coming months as the Eurozone’s economy slows. As a result, the trader bets that the euro will
fall against the U.S. dollar and sells short €100,000 at an exchange rate of 1.15. Over the next
several weeks the ECB signals that it may indeed ease its monetary policy. That causes the
exchange rate for the euro to fall to 1.10 versus the dollar. It creates a profit for the trader of
$5,000.
By shorting €100,000, the trader took in $115,000 for the short-sale. When the euro fell, and the
trader covered their short, it cost the trader only $110,000 to repurchase the currency. The
difference between the money received on the short-sale and the buy to cover is the profit. Had
the euro strengthened versus the dollar, it would have resulted in a loss.