Foreign exchange market

The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies. ^[1]

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

Main foreign exchange market turnover, 1988 - 2007, measured in billions of USD.

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

Contents

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• 1 Market size and liquidity
• 2 Market participants
  • 2.1 Banks
  • 2.2 Commercial companies
  • 2.3 Central banks
  • 2.4 Hedge funds as speculators
  • 2.5 Investment management firms
  • 2.6 Retail foreign exchange brokers
  • 2.7 Non-bank Foreign Exchange Companies
  • 2.8 Money Transfer/Remittance Companies
• 3 Trading characteristics
• 4 Determinants of FX Rates
  • 4.1 Economic factors
  • 4.2 Political conditions
  • 4.3 Market psychology
• 5 Algorithmic trading in foreign exchange
• 6 Fundamental trading in foreign exchange
• 7 Technical Analysis in foreign exchange
• 8 Financial instruments
  • 8.1 Spot
  • 8.2 Forward
  • 8.3 Future
  • 8.4 Swap
  • 8.5 Option
  • 8.6 Exchange-Traded Fund
• 9 Speculation
• 10 See also
• 11 References
• 12 External links

Retail forex platform

Retail forex trading is a segment of the vast foreign exchange market. It has been speculated that it represents 2 percent of the whole forex market which amounts to $50-60 billion ^[1][2] in daily trading turnover. Due to the increasing tendency in the past years of the gradual shift from traditional intrabank 'paper' trading to the more advanced and accurate electronic trading, there has been spur in software development in this field. This change provided different types of trading platforms and tools intended for the use by banks, portfolio managers, retail brokers and retail traders.

One of the most important tools required to perform a forex transaction is the trading platform providing retail traders and brokers with accurate currency quotes.

[edit] History and new developments

Since 1996, when retail forex trading was introduced, several brokers who lacked the sufficient tools developed their own trading platforms tailored specifically to their needs. These platforms were good enough at the time but required constant investments in R&D and its development cost too much. This was the first wave.

The second wave was in the early 2000s: several software companies entered the retail forex trading market by launching their own versions of trading platforms. Typically these versions were cumbersome for both front-end users (retail traders) and back-end users (retail brokers) due to the misunderstanding of the developers about the forex market and also because of the insufficient programming tools/languages at the time. Simultaneously most of the retail brokers kept using and developing their own systems as they waited for better platforms which were yet to be developed.

There are currently few to no brokers which were part of the first wave trading systems. By now most of the first wave brokers have either vanished, merged or progressed to the second wave trading platforms – the most common example of which is Metaquotes.

It is only in the last couple of years that the advanced trading platforms started to emerge. These platforms put much stronger emphasis on the user interface (GUI) making it more accessible to the retail traders while making trading on it very simple and intuitive. Moreover a very strong emphasis was put on the back-end which allowed the retail brokers better control over their operations, better reporting and accurate system and ways to manage marketing campaigns. Gradually this wave is replacing the previous second wave with a major shift now to the friendlier and more intuitive systems of the third wave which according to Aite Group are necessary in order to maintain growth ^[3].

Stock market cycles

A cycle or a wave represents a process that tends to repeat itself in time in a more or less regular fashion.

There are many types of business cycles. Some of the most common ones are those that impact the stock market^[1]. In his book The Next Great Bubble Boom, Harry S. Dent Jr., a Harvard graduate and Fortune 100 consultant, outlines several cycles that have specific relevance to the stock market. ^[2]. Some of these cycles have been quantitatively examined for statistical significance.

Some of the major cycles that have been examined by Mr. Dent and others are:

• The four-year presidential cycle in the USA.
• Annual seasonality, in the USA and other countries.
• "The Halloween indicator" (or "Sell in May and Go Away")^[3]
• The "January effect"^[4]
• The lunar cycle^[5]

Many investors and market traders take recourse to these cycles and the insights they provide when making investment decisions. For example investment advisor Mark Hulbert has tracked the long term performance of Norman Fosback’s a Seasonality Timing System that combines month-end and holiday-based buy/sell rules. According to Hulbert, this system has been able to outperform the market with significantly less risk. According to him it has the best risk-adjusted performance of any system his newsletter tracks^[6]. Other authors and investment advisors contend that there are four stages in any major cycle whether it is an individual stock or a market sector. These four stages are (1) period of consolidation or base building (2) upward advancing stage (3) top area and (4) declining phase. ^[7]

Contents

[hide]

• 1 Causes
• 2 Compound cycles
• 3 Use of multiple screens
• 4 Implications
• 5 See also
• 6 References
• 7 External Links

Taxation

According to much national or state legislation, a large array of fiscal obligations are taxed for capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on the stock market, in particular in the stock exchanges. However, these fiscal obligations may vary from jurisdiction to jurisdiction because, among other reasons, it could be assumed that taxation is already incorporated into the stock price through the different taxes companies pay to the state, or that tax free stock market operations are useful to boost economic growth.

Investment strategies

One of the many things people always want to know about the stock market is, "How do I make money investing?" There are many different approaches; two basic methods are classified as either fundamental analysis or technical analysis. Fundamental analysis refers to analyzing companies by their financial statements found in SEC Filings, business trends, general economic conditions, etc. Technical analysis studies price actions in markets through the use of charts and quantitative techniques to attempt to forecast price trends regardless of the company's financial prospects. One example of a technical strategy is the Trend following method, used by John W. Henry and Ed Seykota, which uses price patterns, utilizes strict money management and is also rooted in risk control and diversification.

Additionally, many choose to invest via the index method. In this method, one holds a weighted or unweighted portfolio consisting of the entire stock market or some segment of the stock market (such as the S&P 500 or Wilshire 5000). The principal aim of this strategy is to maximize diversification, minimize taxes from too frequent trading, and ride the general trend of the stock market (which, in the U.S., has averaged nearly 10%/year, compounded annually, since World War II).

Margin buying

In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value. In the United States, the margin requirements have been 50% for many years (that is, if you want to make a $1000 investment, you need to put up $500, and there is often a maintenance margin below the $500). A margin call is made if the total value of the investor's account cannot support the loss of the trade. (Upon a decline in the value of the margined securities additional funds may be required to maintain the account's equity, and with or without notice the margined security or any others within the account may be sold by the brokerage to protect its loan position. The investor is responsible for any shortfall following such forced sales.) Regulation of margin requirements (by the Federal Reserve) was implemented after the Crash of 1929. Before that, speculators typically only needed to put up as little as 10 percent (or even less) of the total investment represented by the stocks purchased. Other rules may include the prohibition of free-riding: putting in an order to buy stocks without paying initially (there is normally a three-day grace period for delivery of the stock), but then selling them (before the three-days are up) and using part of the proceeds to make the original payment (assuming that the value of the stocks has not declined in the interim).

Derivative instruments of Stock Exchange

Financial innovation has brought many new financial instruments whose pay-offs or values depend on the prices of stocks. Some examples are exchange-traded funds (ETFs), stock index and stock options, equity swaps, single-stock futures, and stock index futures. These last two may be traded on futures exchanges (which are distinct from stock exchanges—their history traces back to commodities futures exchanges), or traded over-the-counter. As all of these products are only derived from stocks, they are sometimes considered to be traded in a (hypothetical) derivatives market, rather than the (hypothetical) stock market.