Introduction to FX Trading

The world is becoming more interconnected every day. Businesses and individuals around the globe are increasingly conducting transactions that involve payments of one currency to another.

This is the foreign exchange market, sometimes referred to as the currency market, Forex or simply the FX market. The FX market is huge, global and very fragmented. FX transactions can be conducted by large global banks, regional broker or dealers and even small, unregulated boutiques.

The FX marketplace is overwhelming, conducted outside of exchanges in what is known as the over-the-counter or OTC market. Exchange-traded FX futures are a growing portion of this vast international marketplace.

The growth in exchange-traded and cleared FX products is due to the highly transparent nature of exchange-traded products and also the safety that is derived from central clearing and post-trade risk collateralization, which reduces counterparty risk.

Purchasing Power Parity and Interest Rate Parity

To understand the FX markets, a little background on some of the economic theories of exchange rates might be useful.

Purchasing Power Parity (PPP) is based on the law of one price, where the cost of an identical good should be the same around the world after exchange rate adjustment.

Interest Rate Parity (IRP), like PPP, is also based on the law of one price. It suggests that an investment asset in one country should yield the same as one in another country, after adjusting for exchange rates.

Size of the FX Marketplace

The FX market is the largest and deepest capital market in world. It trades virtually around the clock, worldwide, every day.

The Bank of international Settlements (BIS) conducts a survey of the global FX markets every three years. It reports its finding in what is known as the BIS Triennial Survey. The latest BIS Triennial Survey reported all FX transactions globally to an average of $5.3 trillion dollars per day.

To put that into perspective, we can compare FX volume to other global capital markets

OTC derivatives trade approximately $2.1 trillion per day, the U.S. bond market trades roughly $800 billion per day, and the most quoted market, U.S. stocks, trades about $200 billion per day.

Identifying Currencies

Currencies are identified using ISO 4217 Currency Codes. By 1973, the International Organization for Standardization (ISO) established the three-letter codes for currencies we use today.

Code Country & Currency

USD United States Dollar

AUD Australian Dollar

BRL Brazilian Real

CAD Canadian Dollar

CHF Swiss Franc

CLP Chilean Peso

CNY Chinese Yuan Renminbi

COP Colombian Peso

EUR Euro Member Countries

GBP British Pound

HKD Hong Kong Dollar

ILS Israeli Shekel

INR Indian Rupee

JPY Japanese Yen

KRW Korean Won

MXN Mexican Peso

NZD New Zealand Dollar

RUB Russian Ruble

ZAR South African Rand