Forex Currency

Traveling from one country to another for business or pleasure involves changing currencies. The largest and most liquid financial market in the world is devoted solely to this task: foreign exchange (forex). Trillions of dollars’ worth of currencies enter and exit this market on a daily basis. This tremendous liquidity is focused on the so-called major currencies, which are issued by global economic powers like the United States, Great Britain and Japan. According to the currency website XE, the top five currencies are the U.S. dollar, the euro, the British pound, the Canadian dollar and the Australian dollar. Among currencies, the U.S. dollar reigns supreme as the world’s reserve currency.

World governments and central banks are required to hold U.S. dollars by the current international financial system. The global forex market is open and active for the entire week with the exception of Sunday. The forex market is split between world trading centers. The large centers are located in Tokyo, London and New York. London is considered the international financial capital and its influence in the forex market reflects this status. Minor centers are located in Australia, Hong Kong, Singapore and the Middle East. This worldwide market structure is what enables the forex market to remain open almost continuously.

Each currency is valued against every other currency. This creates a series of currency pairs, each with its own exchange rate. A business traveler changing his U.S. dollars into euros has to pay attention to both exchange rates: the euro to dollar rate and the dollar to euro rate. The two exchange rates formed by exchanging two currencies for one another are not always the same, although they tend to closely track each other’s movements. The changing and fluid nature of the forex market means that exchange rates can quickly shift at any hour of the day or night.

Participants in the forex market include central banks, foreign governments, international corporations, international banking institutions and small players like tourists and speculators. XE reports that 175 currencies exist throughout the world. All currencies are not created equal, and speculators trading in exotic foreign currencies like the South African rand or Zimbabwean dollar have a hard time due to the lack of liquidity. There are always two parties to every trade. When few counterparties are available, traders are stuck with their positions, which leaves them open to massive losses when trading currencies that are outside of the major pairs.

Central banks are the largest players in the forex market. The Bank of Japan, to use a popular example, routinely intervenes in the forex market to maintain a low value for the yen against other major currencies. Other central banks send ripples throughout the world in their efforts to carry out different monetary policies. Forex traders and speculators must pay close attention to the actions and decisions of central banks, which can be telegraphed instantaneously around the world through the mechanism of changing exchange rates. Forex can be treacherous if a speculator is unprepared.

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