Basic of the Basics

what is forex?

The Foreign Exchange market, also referred to as the "FOREX" or "Forex" or "Retail forex" or "FX" or "Spot FX" or just "Spot" is the largest financial market in the world, with a volume of over $4 trillion a day. If you compare that to the $25 billion a day volume that the New York Stock Exchange trades, you can easily see how enormous the Foreign Exchange really is. It actually equates to more than three times the total amount of the stocks and futures markets combined! Forex rocks!

what is traded on the foreign exchange market?

The simple answer is money. Forex trading is the simultaneous buying of one currency and the selling of another. Currencies are traded through a broker or dealer, and are traded in pairs; for example the euro and the US dollar (EUR/USD) or the British pound and the Japanese Yen (GBP/JPY).

Because you're not buying anything physical, this kind of trading can be confusing. Think of buying a currency as buying a share in a particular country. When you buy, say, Japanese Yen, you are in effect buying a share in the Japanese economy, as the price of the currency is a direct reflection of what the market thinks about the current and future health of the Japanese economy.

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

Unlike other financial markets like the New York Stock Exchange, the Forex spot market has neither a physical location nor a central exchange. The Forex market is considered an Over-the-Counter (OTC) or 'Interbank' market, due to the fact that the entire market is run electronically, within a network of banks, continuously over a 24-hour period.

Until the late 1990's, only the "big guys" could play this game. The initial requirement was that you could trade only if you had about ten to fifty million bucks to start with! Forex was originally intended to be used by bankers and large institutions - and not by us "little guys". However, because of the rise of the Internet, online Forex trading firms are now able to offer trading accounts to 'retail' traders like us.

All you need to get started is a computer, a high-speed Internet connection, and the information contained within this site.

BabyPips.com was created to introduce novice or beginner traders to all the essential aspects of foreign exchange, in a fun and easy-to-understand manner.

Forex basics: Part 1

The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies.

The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars.

In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of

its trading volumes,
the extreme liquidity of the market,
its geographical dispersion,
its long trading hours: 24 hours a day except on weekends (from 22:00 UTC on Sunday until 22:00 UTC Friday),
the variety of factors that affect exchange rates.
the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes)
the use of leverage
As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks. According to the Bank for International Settlements,[2] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion. Trading in the world's main financial markets accounted for $3.21 trillion of this. This approximately $3.21 trillion in main foreign exchange market turnover was broken down as follows:

$1.005 trillion in spot transactions
$362 billion in outright forwards
$1.714 trillion in foreign exchange swaps
$129 billion estimated gaps in reporting

Forex basics: Part 2

Presently, the foreign exchange market is one of the largest and most liquid financial markets in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008.

Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%. In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.

Exchange-traded FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

Several other developed countries also permit the trading of FX derivative products (like currency futures and options on currency futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Most emerging countries do not permit FX derivative products on their exchanges in view of prevalent controls on the capital accounts. However, a few select emerging countries (e.g., Korea, South Africa, India) have already successfully experimented with the currency futures exchanges, despite having some controls on the capital account.

FX futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).
Top 10 currency traders
% of overall volume, May 2009 Rank     Name     Market Share
1     Flag of Germany Deutsche Bank     20.96%
2     Flag of Switzerland UBS AG     14.58%
3     Flag of the United Kingdom Barclays Capital     10.45%
4     Flag of the United Kingdom Royal Bank of Scotland     8.19%
5     Flag of the United States Citi     7.32%
6     Flag of the United States JPMorgan     5.43%
7     Flag of the United Kingdom HSBC     4.09%
8     Flag of the United States Goldman Sachs     3.35%
9     Flag of Switzerland Credit Suisse     3.05%
10     Flag of France BNP Paribas     2.26%

Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues have made it easier for retail traders to trade in the foreign exchange market. In 2006, retail traders constituted over 2% of the whole FX market volumes with an average daily trade volume of over US$50-60 billion (see retail trading platforms). Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 34.1% in April 2007. The ten most active traders account for almost 80% of trading volume, according to the 2008 Euromoney FX survey.These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 on a retail broker. Minimum trading size for most deals is usually 100,000 units of base currency, which is a standard "lot".

These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100/1.2300 for transfers, or say 1.2000/1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e., 0.0003). Competition is greatly increased with larger transactions, and pip spreads shrink on the major pairs to as little as 1 to 2 pips.