The concept of a vast currency market is foreign to the average individual. Once it is broken down into simple terms, however, it is not hard to understand the foreign exchange market and to use it as a financial instrument for future investing.
Whether or not you are aware of the fact, you already play a role in the Forex market. The simple fact that you have money in your pocket makes you an investor in currency, more particularly, an investor in U.S Dollars! The money in your wallet and in your savings account is in U.S. Dollars. The value of your mortgage, stocks, bonds, and other investments is expressed in U.S. Dollars. In other words, unless you are among the few Americans who have foreign bank accounts or have bought a modest amount of foreign currencies or securities, you invest in U.S. Dollars.
By holding U.S. Dollars, you have elected not to hold the currencies of other nations. Your purchase of stocks, bonds, and other investments, along with money deposited into your bank account represents investments which rely heavily on the integrity of the value of the currency in which it is denominated---the U.S. Dollar. Due to the changing value of the U.S. Dollar and the resultant fluctuation in exchange rates, your investment portfolio may have experienced changes in value, thus affecting your overall financial status. With this in mind, it should be no surprise that many shrewd investors have taken advantage of the fluctuation in exchange rates, using the volatility of the foreign exchange market as a way to increase their capital.
The foreign exchange market has experienced many changes since its inception. For years, the United States and its allies, under the Bretton Woods Agreement, participated in a system in which a currency’s exchange rate was tied to the amount of gold reserves belonging to that nation. In the summer of 1971, however, President Nixon took the United States off the gold standard, creating floating exchange rates. Today, supply and demand for a particular currency is the driving factor in determining exchange rates. The removal of obstacles, such as the fall of Communism, and increasing opportunities, such as the dramatic growth of the Asian and Latin American economies have created new opportunities for investors.
Recent increases in international trade has made the economies of all nations more interrelated. Regularly reported economic figures from around the world, such as inflation or unemployment levels, as well as unexpected events, such as natural disasters or military coups, alter the desirability of holding a particular currency, thus influencing the demand for that currency. The U.S. Dollar, therefore, fluctuates constantly against the currencies of other countries. The current web of international trade and the resulting fluctuations in exchange rates have created the world's largest market---the foreign exchange market, a market whose vast size makes it the most efficient and most liquid of all markets.
The foreign exchange market is a cash inter-bank or inter-dealer market. Foreign exchange, however, is not a "market" in the traditional sense, since there is no centralized location for trading activity. Trading occurs over the telephone and through computer terminals at thousands of locations worldwide. The direct inter-dealer market consists of dealers with currency settlement capabilities trading as principals. This segment of the market generates a large portion of the overall foreign exchange trade volume. Trading between dealers creates the largest turnover in the market, making foreign exchange the most liquid of all markets.
Trading approximately $1.5 trillion every day, the foreign exchange market is the largest financial market in the world. The foreign exchange market has traditionally been available to banks, money managers, and large financial institutions only. These entities have realized large gains via currency trading over the years due to their hold on the market. The market is now linked to a worldwide network of currency traders, including banks, central banks, brokers, and customers, such as importers and exporters, and offers opportunities not only to banks and institutions, but to individual investors as well.