What Is Traded in Forex Markets?

Businesses often use the forex markets to hedge their currency risk exposures.

The foreign exchange market, known as the FX or forex market, is the largest financial market in the world where different currencies are bought and sold. Companies often use the forex markets to manage currency fluctuation risk. The markets are volatile and losses can accrue rapidly. The Commodity Futures Trading Commission (CFTC) is the U.S. federal agency charged with overseeing the commodities markets, including foreign currency trading.

Facts

In today's global business environment, companies often buy and sell goods in foreign currencies. For example, a U.S. computer manufacturer may buy semiconductor chips from Japanese supplier and pay him in Japanese yen or U.S. dollars. The forex markets maintain exchange rates between the dollar and the yen, and between other currency pairs, to facilitate these transactions. The forex markets trade nonstop from Sunday evening to Friday afternoon.

Currencies

Forex trading involves buying one currency and selling another simultaneously. Forex quotes are provided in currency pairs: the first is the "base" currency and the second is the "counter" currency. For purchases, the base currency is bought and the counter currency is sold; for sales, it's the reverse. For example, if the USD/JPY -- U.S. dollar to Japanese yen -- exchange rate is 83.335, it means that 83.335 Japanese yen will buy $1. The four major currency pairs are EUR/USD, USD/JPY, GBP/USD and USD/CHF, where EUR, CHF and GBP represent the euro, Swiss franc and British pound, respectively. Currency crosses are pairs that do not involve the U.S. dollar -- for example, EUR/CHF, EUR/GBP and JPY/CHF. Exotics are pairs that are currencies of developed nations paired with developing nation currencies -- for example, USD/MXN and USD/SGD, where MXN and SGD represent the Mexican peso and the Singapore dollar, respectively.

Trading

Investors and traders benefit from the liquidity and size of the forex market. Liquidity means better bid/ask spreads -- the difference between the buyer's bid price and the seller's ask price -- and improved chances of getting orders filled quickly. Unlike stock trading, there are no commissions because traders deal directly with market makers who profit from the bid/ask spread. Most forex trading is done on margin, which allows investors to trade at higher volumes. Margin rates are often as high as 95 percent, which means that an investor can trade up to $20,000 in foreign currency with only $1,000 of equity in her account. Order types include market order, where the trade happens at the market price, and limit order, where the trader specifies a price.

Caution

The CFTC cautions investors to be careful of scam artists who attract customers with ads that often sound too good to be true. For example, ads may promise large returns in a short time with little or no downside risk; in some cases, the investment is never actually placed in the market but diverted or stolen by the fraudsters. Investors should watch for warning signs, including unsolicited phone calls offering investments and high-pressure sales tactics.

References

• U.S. Securities and Exchange Commission: Forex -- Foreign Currency Transactions
• Trading Markets: How is Trading Forex Different from Trading Stocks? John Forman; May 2010
• Go Currency: The Foreign Exchange Market for Beginners
• Online Forex Trading: Introduction to Currency Pairs
• U.S. Commodity Futures Trading Commission: Consumer Protection -- Foreign Currency Trading

Resources

• FX Street: Foreign Exchange Rates Live
• Yahoo! Finance: Currencies Center