Category: Forex Tips

As a whole, currencies make up the most actively traded assets in the world. Almost $6 trillion in different currencies change hands each day in the foreign exchange market, which has become the largest financial market on the planet.

The forex market consists of many participants, some wishing to hedge foreign exchange risk for commercial ventures, while other participants trade the market with the sole intention of making a profit.

Because of the enormous depth of the market and a large number of participants — including a growing number of retail forex traders — no other financial market can offer the profit-making possibilities of the forex market.

Read our Previous Article: The Euro’s Rising Influence

The Incomparable Size of the Forex Market

As mentioned above, the daily turnover in the forex market approximates $6 trillion. This number surpasses the size of the international bond market by a factor of 10 and that of the international equity market by a factor of 50, according to some recent estimates.

Because of this large size, and the fact that currency trading goes on continuously 24 hours, five days a week, trading in the forex market offers more opportunities than any other market in the world.

Furthermore, trading in the forex market was once limited to large banks, multi-national enterprises, and high worth individuals. Nevertheless, with retail Internet forex brokers, anyone with a computer, an Internet connection and a small amount of money can now trade in the forex market.

With a large number of participants in the forex market and the recent growth provided by the retail market, the resulting liquidity makes for even better trading conditions.

Liquidity and its Benefits in the Forex Market

One of the major reasons that the currencies traded in the forex market has become the most traded asset in the world is because of the high degree of liquidity generally seen in the forex market.

In basic market terminology, the word liquidity refers to the ability to convert an asset into hard cash, as well as the amount of activity which occurs in an asset over a period of time.

For example, the market for real estate would not fit the description of a liquid market. Essentially, owning real estate as an investment will not guarantee that you can liquidate the asset quickly since sometimes it can take years to liquidate real estate.

A spot forex transaction, on the other hand, usually settles within two days of the transaction, and when trading the Canadian Dollar against the U.S. Dollar, spot trades settle in just one day.

Some of the pricing advantages of liquidity consist of lower transaction costs and tighter bid/offer spreads. Also, high liquidity means that large transactions can be handled smoothly and it tends to ensure a more orderly market, with an absence of price vacuums which can cause extreme price swings.

One of the most important events in the foreign exchange market over the last 25 years has been the consolidation of many of the former national currencies of Europe into the single currency of the European Monetary Union that is usually known as the Euro.

The concept of a common currency for a united Europe to simplify transactions among European nations was an idea which had become popular among many corporations and residents of the European community.

At first, various exchange rate regimes were attempted such as the currency snake and the European Exchange Rate Mechanism or ERM. Their eventual failure ultimately led to the development of the Euro which brought the 28 members European trading bloc much closer to having a single currency.

Read our Previous Article: Understanding Reserve Currency

How the European Union was Formed

The EU or European Union has its roots in the European Community or EC founded in Rome in 1957. This led to the signing of the Maastricht Treaty enacted on November 1st, 1993.

In 1995, Austria, Sweden, and Finland joined the European Union, followed by another ten nations in 2004. With Romania and Bulgaria joining in 2007, that brought the total number of member nations in the European Union to 27 countries.

Having a combined population estimated at more than 500 million people, the European Union contributed approximately 28% of the nominal gross world product in 2009, amounting to over 16.5 trillion U.S. Dollars.

The Euro as a Reserve Currency

The Euro was released in Europe as an accounting currency in 1999, and a circulating currency in 2002. Since then, a growing number of national central banks have begun replacing the U.S. Dollar with the Euro as a reserve currency.

A number of reasons behind this situation include the exorbitant U.S. government fiscal spending, seemingly endless wars fought overseas by the U.S. military, worsening U.S. trade and budget deficits and a real estate crisis to top it all off. Overall, these risk factors do not contribute to the safety of the U.S. Dollar as an investment, and central banks are increasingly acknowledging this.

For these and other reasons, the Euro has become the number two reserve currency in the world, accounting for a total of 28% of global currency reserves as of 2009 and significantly increasing its influence.

This is considerably higher than the nearly 18% of the global reserves the Euro made up when the currency was initially introduced in 1999. For comparison purposes, the same ten year time period saw U.S. Dollar reserves drop from 71% to 61% of global currency reserves.

The Euro’s Influence on International Trade Increases

Because of the United States’ status as a trading partner with many nations in the world, the U.S. Dollar has traditionally been held as the reserve currency of choice for many major U.S. trading partners.

Nevertheless, as the further consolidation of the Eurozone progresses, many smaller countries that are non-members with strong commercial ties to European countries are considering pegging their regional currencies to the Euro.

Even so, the U.S. Dollar continues being the primary currency for trading in key commodities such as crude oil and gold. Still, the Euro is increasingly becoming the currency which oil producing nations are favoring over the U.S. Dollar for transactions in oil.

The move to the Euro on oil transactions would further hurt the Dollar’s status in favor of the Euro, and would very likely lead to an even further increase in the Euro’s overall influence in global financial markets.

In forex market terminology, a reserve currency consists of a currency held by a nation’s central bank set aside, or “in reserve”, for the purpose of paying international debts and for stabilizing or otherwise influencing the exchange rate of their own currency.

Reserve currencies often also make up the accepted method of payment for key commodities such as crude oil and gold.

Read our Previous Article: Forex Market Players – Know Types of Participants

Although the U.S. clearly predominates as a reserve currency, accounting for over 60% of global reserves, other currencies are also commonly held in reserve.

The primary currencies which governments hold in reserve in their central banks, listed in order of importance, are:

• The U.S. Dollar
• The E.U. Euro
• The U.K. Pound Sterling
• The Japanese Yen
• The Swiss Franc

Before being replaced by the Euro, the German Deutschmark and the French Franc were also held as reserve currencies.

Why the U.S. Dollar is the Primary Global Reserve Currency

Since the early part of the 20th century, the U.S. dollar has been the leading global reserve currency. In fact, many currencies were pegged to the Dollar because of the Dollar’s convertibility to gold since it was on the gold standard at that time.

Near the end of the Second World War, the Dollar was the currency selected at the Bretton Woods conference to which all other major national currencies would be pegged, with gold fixed at $35 U.S. Dollars per ounce.

This led to an era of relative global monetary stability until 1971, when then President Richard Nixon ended the Dollar’s convertibility to gold, effectively taking the U.S. Dollar off of the gold standard.

The event heralded the arrival of the age of floating exchange rates for fiat currencies, i.e. paper currencies issued by governments that were backed by nothing but the faith and credit of the issuer.

Despite the Dollar being taken off of the gold standard and serious problems with the U.S. economy and huge fiscal deficits, the U.S. Dollar continues benefiting from being the world’s number one reserve currency by having access to lower borrowing costs, for instance.

The Rise of the Euro as a Reserve Currency

As a result of the recent European sovereign debt crisis in 2009-2010, the beleaguered Euro has lost a considerable amount of its value against other currencies, prompting some central banks to cut down on their Euro holdings.

Nevertheless, the Euro continues having avid supporters who often believe the Euro is due to become the world’s next primary reserve currency. Only time will tell if these supporters are right, although when the Euro was introduced in 1999 it made up only 17.9% of global reserves, compared to the 28.1% that it accounts for now.

Compare this notable increase in Euro reserves to the corresponding fall in Dollar reserves, which declined from 70.9% of global reserves in 1999 to just 61.5% by 2009. Basically, it seems that the rise of the Euro as a reserve currency is now well underway.

Read Next: The Euro’s Rising Influence

A primary reason for the forex market’s popularity among retail forex traders is that it trades virtually around the clock during the usual work week.

In essence, you can get a competitive quote on the active currency pairs from the Sydney open at 5 PM EST on Sunday until the New York close at 5 PM EST on Friday. Although the best times to trade forex tend to be when two major financial centers like Tokyo and London or London and New York are open.

A significant advantage of this 24-hour forex trading is that you can leave a Good ‘Til Canceled or GTC order with your forex broker or bank. Such an order will then be worked overnight or even throughout the week until you request that it be disregarded.

This significantly enhances your chances of being executed at your desired price, which is a good thing if the order involves taking profits at a better level than the prevailing market.

Read our Previous Article: Forex Majors, Minors and Exotics Currencies

When Forex Trades in the Major Financial Centers

The forex trading day starts at 5 PM EST as the market opens in Sydney, Australia. Nevertheless, the start of this trading session can be quite thin and hence dealing spreads can widen and it may be easier for large traders to trigger stop-loss orders.

Liquidity then grows significantly as Tokyo opens at 7 PM EST. Tokyo’s session subsequently overlaps with the forex market’s primary trading center of London between the hours of 3 AM EST when London opens and 4 AM EST when Tokyo closes.

New York then opens at 8 AM EST. This starts a very active trading period for the forex market as the trading sessions of the major financial centers of New York and London overlap between the New York open at 8 AM EST and the London close at 12 Noon EST.

New York then closes and hands off to Sydney at 5 PM EST, as another trading day begins in the forex market.

Benefits of Trading During Overlapping Sessions

Although the forex market trades around the clock, the forex market is most active when trading sessions for the major forex trading centers of London, New York, and Tokyo overlap.

By having more than one major dealing center open simultaneously, the forex market generally sees a higher trading volume and an improved degree of liquidity that can include better-dealing spreads as market makers in both centers compete for business.

Traders employing short-term dealing strategies like scalping or day trading will often have a better chance to profit during such highly liquid periods.

Fewer Holidays in the Forex Market

Although stock markets tend to subject to closure on bank holidays in the country in which they are located, the forex market observes far fewer holidays, and then usually only partially.

Basically, when a bank holiday closes trading in one country due to a regional, religious or national holiday, other countries that do not celebrate that event often may not close down forex trading at all due to differing cultures.

For example, Asian countries like Japan may be celebrating the Buddha’s birthday and take the day off, while the forex market will generally remain open in the United States, Australia, and Europe.

Although trading may be thinned down somewhat and show tighter trading ranges during such partial holidays, you can generally still get a forex quote if necessary.

Read Next: Forex Market Players – Know Types of Participants

In the fundamental terminology used in the forex market, each currency is placed in one of three major groups according to their average daily trading volume and liquidity.

The most actively traded currency pairs belong to the group known as the Majors, while somewhat less active currency pairs belong to the minors. The rarer currencies with the lowest trading volume fall into the exotic currency group.

The sections below list the currencies corresponding to these groups and describe each currency group in further detail.

Currencies Listed According to Group

Some representative currencies included in the three groups and their three letter ISO 4217 currency codes are:

Majors

• USD:        United States’ Dollar
• GBP:        United Kingdom’s Pound Sterling
• EUR:        European Union’s Euro
• CHF:        Switzerland’s Swiss Franc
• JPY:          Japan’s Japanese Yen

Minors

Commodity Dollars

• CAD:              Canada’s Canadian Dollar
• AUD:              Australia’s Australian Dollar
• NZD:              New Zealand’s Dollar

Scandinavian Currencies

• SEK:              Sweden’s Swedish Krona
• NOK:              Norway’s Norwegian Kroner
• DKK:              Denmark’s Danish Kroner

Exotics

• RUB:       The Russian Federation’s Ruble
• HKD:       Hong Kong’s Dollar
• INR:         India’s Indian Rupee
• MXN:       The Mexican Peso
• ZAR:        South Africa’s Rand
• SGD:       Singapore’s Dollar
• KRW:       South Korea’s Won

Major Currencies

The currencies that are included among the majors tend to have a high trading volume and belong to major economies. Also, most of them are used as reserve currencies by central bank and governments.

First among the majors in terms of trading volume is undoubtedly the U.S. Dollar, which accounts for over 85% of daily turnover in the forex market. Also, most currencies trade in pairs against the U.S. Dollar, and those pairs that do not include the U.S. Dollar are known as crosses.

Minor Currencies

The minor currencies consist of those currencies traded somewhat less active than the majors, although their economies are still significant and they also tend to be active in international trade. The minors can be further broken down into the commodity currencies and the Scandinavian currencies.

As their name implies, the commodity currencies, or com dollars as they are also sometimes called, correspond to nations that produce and export natural resources. The value of such currencies tends to be linked to that of the commodities they export, like gold in the case of the Australian Dollar or oil for the Canadian Dollar.

In addition to the commodity currencies, the Minors also include the so-called Scandinavian Currencies or Skandis. These currencies come from the Scandinavian countries of northern Europe that have not yet adopted the Euro.

Exotic or Emerging Market Currencies

All other less actively traded currencies make up the Exotics currency group. These currencies tend to belong to developing countries, and for this reason, they are also commonly called emerging market currencies.

The currencies in this group trade largely as counter currencies against the U.S. Dollar. Also, the markets for this group tend to lack liquidity relative to those for the Majors and Minors.

Read Next: When and Where Forex is Traded