The foreign exchange market, also known as Forex or FX, is the largest financial market in the world. According to Reuters the average Forex daily value crossed five trillion USD in March 2012. Babypips.com adds that if this number is compared to New York Stock Exchange’s volume of 22.4 billion USD, the graph looks something like this:

However, this number includes the whole global foreign exchange market, whereas the retail traders, who are trading the spot market, have the accessible volume of approximately 1.49 trillion USD a day.

At first Forex trading can be a bit confusing as you are not buying anything physical. Therefore you can for example think of buying a currency as buying a share in a particular country similar to buying stocks of a company. This way the price of the currency is a direct reflection of what the market thinks about the current and future health of the economy.

For instance if you buy the British Pound (GBP), you are basically buying a share in the British economy. This means you are betting that the British economy is doing well, and will even get better as time goes. Once you sell those shares back to the market you will hopefully end up with a profit.

In general, the exchange rate of a currency versus other currencies is a reflection of the condition of that country’s economy, compared to other countries’ economies.

The Major Currencies and Currency Pairs

Symbol

Country

Currency

Nickname

USD

United States

Dollar

Buck

EUR

Euro zone members

Euro

Fiber

JPY

Japan

Yen

Yen

GBP

Great Britain

Pound

Cable

CHF

Switzerland

Franc

Swissy

CAD

Canada

Dollar

Loonie

AUD

Australia

Dollar

Aussie

NZD

New Zealand

Dollar

Kiwi

As the currencies are always traded in pairs, Forex trading is simultaneous buying of one currency and selling another.

Pair

Countries

Pair Nickname

EUR/USD

Euro zone / United States

“euro dollar”

USD/JPY

United States / Japan

“dollar yen”

GBP/USD

United Kingdom / United States

“pound dollar”

USD/CHF

United States/ Switzerland

“dollar swissy”

USD/CAD

United States / Canada

“dollar loonie”

AUD/USD

Australia / United States

“aussie dollar”

NZD/USD

New Zealand / United States

“kiwi dollar”

Market Size and Liquidity

The Forex market is an Over-the-Counter (OTC) market, which means that the entire market is run electronically within a network of banks continuously over a 24-hour period. The Forex OTC market is also the biggest and most popular financial market in the world, traded globally by a large number of individuals and organizations. In the OTC market, participants determine who they want to trade with depending on trading conditions, attractiveness of prices, and reputation of the trading counterpart.

The chart below shows the percentages of the most actively traded currencies during the years 1998-2010 according to Global Finance. Please note that not all of the currencies were used anymore in the Year 2010 and as currencies are traded in pairs the total percentage sums up to 200 instead of 100.

Currency  Year 1998  Year 2001  Year 2004  Year 2007  Year 2010  
1 US dollar 86.8 89.86 88.01 85.6 84.86
2 Euro 37.91 37.41 37.04 39.06
3 Deutsche mark 30.45
4 French franc 4.97
5 ECU and other EMS currencies 16.82
6 Slovak koruna 0.03 0.05 0.09
7 Japanese yen 21.72 23.53 20.83 17.25 18.97
8 Pound sterling 11.02 13.05 16.5 14.87 12.88
9 Australian dollar 3.03 4.32 6.02 6.62 7.58
10 Swiss franc 7.06 5.98 6.03 6.82 6.36
11 Canadian dollar 3.53 4.49 4.2 4.29 5.28
12 Hong Kong dollar 0.99 2.24 1.76 2.7 2.36
13 Swedish krona 0.33 2.5 2.19 2.7 2.19
14 New Zealand dollar 0.22 0.56 1.06 1.9 1.59
15 Korean won 0.15 0.8 1.14 1.16 1.51
16 Singapore dollar 1.11 1.05 0.91 1.17 1.42
17 Norwegian krone 0.23 1.46 1.38 2.1 1.32
18 Mexican peso 0.46 0.83 1.11 1.31 1.25
19 Indian rupee 0.09 0.23 0.32 0.71 0.95
20 Russian Rouble 0.3 0.35 0.63 0.75 0.9
21 Polish zloty 0.06 0.45 0.38 0.76 0.81
22 Turkish new lira 0.04 0.11 0.18 0.74
23 South African rand 0.4 0.94 0.72 0.91 0.72
24 Brazilian real 0.22 0.48 0.27 0.39 0.69
25 Danish krone 0.26 1.19 0.87 0.84 0.57
26 New Taiwan dollar 0.11 0.27 0.42 0.36 0.48
27 Hungarian forint 0.04 0.02 0.19 0.27 0.43
28 Chinese renminbi 0.01 0.01 0.1 0.45 0.32
29 Malaysian ringgit 0.04 0.07 0.05 0.13 0.28
30 Thai baht 0.14 0.15 0.2 0.2 0.19
31 Czech koruna 0.28 0.19 0.15 0.21 0.19
32 Philipine peso 0.03 0.04 0.04 0.11 0.17
33 Chilean peso 0.08 0.18 0.12 0.11 0.16
34 Indonesian rupiah 0.07 0.05 0.11 0.11 0.15
35 Israeli new shekel 0.1 0.11 0.15 0.15
36 Colombian peso 0.03 0.04 0.05 0.1
37 Saudi Riyal 0.08 0.07 0.04 0.06 0.06
38 Other currencies 8.91 6.55 6.56 7.63 5.31
39 All currencies 200 200 200 200 200

The next chart shows the official foreign exchange reserves according to International Monetary Fund (IMF):

However, an important thing to note about the Forex market is that most currency trading is based on speculation. In other words, most trading volume comes from traders that buy and sell based on price movements during a day. Babypips.com estimates that the trading volume brought about by the speculators is estimated to be more than 90%!

The scale of the Forex speculative market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high making it easy for anyone to buy and sell currencies. From the perspective of an investor, liquidity is very important as it determines how easily price can change over a given time period. A liquid market environment like Forex enables huge trading volumes to happen with very little effect on price, or price action.

Nevertheless, despite the Forex market is relatively very liquid the market depth can change depending on the currency pair and time of day.