The market, which deals specifically in the currencies, is called the foreign exchange market. It is also called as an OTC [over the counter] market, i.e. there is no physical market place to make deals. Instead, it is a network of banks, brokers and dealers spread across the various financial centers of the world. These players trade in different currencies through telephone, faxes, computers and other electronic network like the SWIFT system [society for worldwide interbank financial telecommunications]. These traders generally operate through a trading room. The deals are mostly finalized orally with written confirmation following later.
The structure of the FOREX market comprises of the large commercial banks, Forex brokers, large corporations and the central banks. Central banks normally enter the market to smoothen out fluctuations in the exchange rate or to maintain fixed exchange rates.
Large commercial banks deal in the market both to execute their clients’ (both individual and corporate) orders and on their own account. They act as market makers in the Forex market i.e. they stand ready to buy and sell various currencies at specific prices at all points of time. The foreign exchange brokers do not actually buy or sell any currency. They do the work of bringing buyers and sellers together. Larger corporations operate in the market on their own and for them selves. They generally deal in the market to satisfy their needs arising out of their normal business operations.
The market in which the commercial banks deal with their customers (both individual and the corporate) is called the retail Forex market, while that in which the banks deals with each other is called the wholesale Forex or the inter bank market. The size of the deals in the retail market is much smaller than that in the interbank market.
The worldwide Forex market is a twenty-four hour market meaning it is open virtually throughout the day, in at least one of the financial markets of the world.
A few services in these markets report the quotes given by the various players on an online basis. Reuters, Knightriders and the Telerate are a few of such services. Some of these services now offer even a screen base trading i.e. the quotes are matched automatically by the system and the orders will be executed.
The world over, about 85% Forex trading arises as a result of transactions between the market makers and speculative transactions with only 15% of the transactions being trade or commerce related. This results in the expectations and the actions of these two groups having an overwhelming impact on the values of the various currencies at least in the short term. On the other hand the presence of the activities of these two groups is essential for liquidity in the market. Competition between the various market makers also ensures that the divergence in the market makers quotes’ is not too large. Speculation in the Forex market is essentially a zero sum game if it is considered as an activity only among the speculators.