Forex Is

Foreign exchange market or Forex is the market for buying and selling currencies. Currencies from all over the word can be traded in Forex which is an OTC (over the counter) market. The Forex market is loosely regulated by the Commodity Futures Trading Commission (CFTC). The National Futures Association (NFA) has regulatory authority over retail brokers and market makers. Forex, the most liquid market in the world operates round the clock.

Who are the Market Participants? Why do they trade ?

Governments and Banks:Governments and central banks of various countries deal in the forex market with the intention of maintaining their foreign exchange reserves. Many a times governments buy and sell currency with the intention of achieving a favorable balance of payment (BOP) situation. For instance if a country is interested in increasing its exports, it might sell its currency in forex market. This would increase the supply of the currency. An increase in supply would result in currency depreciation. Once the currency depreciates, exports increase; making the current account balance favorable and the BOP satisfactory. Since governments and central banks have unlimited authority and access to money, they can exercise significant influence on the direction of the market.

Business Firms: Firms deal in the forex market mainly in order to hedge against unfavorable exchange rate movements. For example, a firm in the U.S. engaged in the business of supplying corn to Europe would receive payments in EUR. Suppose EUR depreciates, the U.S. based firm would suffer. This is because the firm can now buy fewer dollars with the euros. In order to avoid this situation the firm can enter into a future contract to lock in a favorable rate at which euros can be exchanged for dollars. This process is known as hedging.

Banks and Financial Institutions: Banks and other financial institutions also participate in the forex market. Banks profit from the bid-ask spread. They deal in a particular segment of the market known as the interbank market. In this market, banks who have credit relations with each other indulge in trading currencies. The size of the bank in monetary terms would determine its credit relation and its importance in the interbank market. Individuals who need to exchange currency can approach their local banks.