Basics of Foreign Exchange Market

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Basics of Foreign Exchange Market
The foreign exchange market or the currency exchange market is decentralized financial market for trading currencies. The foreign exchange market is normally based on currency trading platforms, where different major currencies of the world are traded.

The foreign exchange market acts as a medium by bringing two parties together wishing to trade currencies at some agreeable rate. It's a market where you can exchange one country's currency for that of another simultaneously at some exchange rate, for example, if you want to sell Indian Rupee (INR) to get the U.S. dollar (USD), there must be someone else wanting to sell USD for INR at the same exchange rate.

The foreign exchange market in India started in 1978, when government allowed banks to trade foreign exchange with one another. And, today investors and traders around the world are looking to the foreign exchange market as a new speculation opportunity.

Market Participants:
Foreign exchange market attracts participants from around the world. Mainly banks, commercial companies, central banks, investment management firms, retail foreign exchange traders, importers, exporters, hedge funds as speculators, etc.

About 70 percent to 90 percent of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were entirely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They enter into a trade with the intention of profit when the value of currencies purchased or sold undergo a change in the interest of the buyer.

What instruments are traded in foreign exchange market?
There are many currencies of the world get traded in foreign exchange market which provides great liquidity to investors around the globe. So, the trading is always done in pairs – Currency Pairs, one currency is bought and the other is sold. Together, they make up and that is known as the "exchange rate".

The most traded currency pairs in India are: U.S. Dollar vs Indian Rupee (USD/INR), Euro vs Indian Rupee (EUR/INR), Great Britain Pound vs Indian Rupee (GBP/INR) and Japanese Yen vs Indian Rupee (JPY/INR).

So, for instance, if a trader goes long or buys the US dollar, she or he is simultaneously buying the USD and selling the INR. If the same trader goes short or sells the Euro, she or he is simultaneously selling the EUR and buying the INR.

The first currency of each currency pair is referred as the base currency, while second currency is referred as the counter or quote currency. Each currency pair is expressed in units of the counter currency needed to get one unit of the base currency.

So, if the price or quote of the USD/INR is 44.56, it means that 44.56 Indian Rupees are needed to get one Dollar.

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Read more about: derivatives, currency, futures, forwards
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