Foreign exchange market

The foreign exchange market (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. By trading volume, it is by far the largest market in the world, followed by the credit market.^[1]

The main participants are the larger international banks. Financial centres function as anchors of trading between a range of multiple types of buyers and sellers around the clock, with the exception of weekends. As currencies are always traded in pairs, the market does not set a currency's absolute value, but rather determines its relative value by setting the market price of one currency if paid for with another. Example: 1 USD is worth 1.1 Euros or 1.2 Swiss Francs etc. The market works through financial institutions and operates on several levels. Behind the scenes, banks turn to a smaller number of financial firms known as "dealers", who are involved in large quantities of trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the "interbank market". Trades between dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little supervisory entity regulating its actions. In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency.

The foreign exchange market assists international trade and investments by enabling currency conversion. For example, it permits a business in the US to import goods from European Union member states, and pay Euros, even though its income is in United States dollars. It also supports direct speculation and evaluation relative to the value of currencies and the carry trade speculation, based on the differential interest rate between two currencies.^[2]

The modern foreign exchange market began forming during the 1970s. This followed three decades of government restrictions on foreign exchange transactions under the Bretton Woods system of monetary management, which set out the rules for commercial and financial relations among major industrial states after World War II. Countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed per the Bretton Woods system. The foreign exchange market is unique because of the following characteristics:

• huge trading volume, representing the largest asset class in the world leading to high liquidity;
• geographical dispersion;
• continuous operation: 24 hours a day except weekends, i.e., trading from 22:00 UTC on Sunday (Sydney) until 22:00 UTC Friday (New York);
• variety of factors that affect exchange rates;
• low profit margins compared with other markets of fixed income; and
• use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks.

Trading in foreign exchange markets averaged US$7.5 trillion per day in April 2022, up from US$6.6 trillion in 2019. Measured by value, foreign exchange swaps were traded more than any other instrument in 2022, at US$3.8 trillion per day, followed by spot trading at US$2.1 trillion.^[3]