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.
This means that the spot forex market is spread all over the globe with no central location. They can take place anywhere, even at the top of Mt. Fuji!
The forex OTC market is by far the biggest and most popular financial market in the world, traded globally by a large number of individuals and organizations.
In the OTC market, participants determine who they want to trade with depending on trading conditions, attractiveness of prices, and reputation of the trading counterpart.
The chart below shows the ten most actively traded currencies.
The dollar is the most traded currency, taking up 84.9% of all transactions. The euro’s share is second at 39.1%, while that of the yen is third at 19.0%. As you can see, most of the major currencies are hogging the top spots on this list!
*Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%
The chart above shows just how often the U.S. dollar is traded in the forex market. It is on one side of a ridiculous 84.9% of all reported transactions!
The Dollar is King
You’ve probably noticed how often we keep mentioning the U.S. dollar (USD). If the USD is one half of every major currency pair, and the majors comprise 75% of all trades, then it’s a must to pay attention to the U.S. dollar. The USD is king!
In fact, according to the International Monetary Fund (IMF), the U.S. dollar comprises roughly 62% of the world’s official foreign exchange reserves! Because almost every investor, business, and central bank own it, they pay attention to the U.S. dollar.
There are also other significant reasons why the U.S. dollar plays a central role in the forex market:
- The United States economy is the LARGEST economy in the world.
- The U.S. dollar is the reserve currency of the world.
- The United States has the largest and most liquid financial markets in the world.
- The United States has a super stable political system.
- The United States is the world’s sole military superpower.
- The U.S. dollar is the medium of exchange for many cross-border transactions. For example, oil is priced in U.S. dollars. So if Mexico wants to buy oil from Saudi Arabia, it can only be bought with U.S. dollar. If Mexico doesn’t have any dollars, it has to sell its pesos first and buy U.S. dollars.
One important thing to note about the forex market is that while commercial and financial transactions are part of trading volume, most currency trading is based on speculation.
In other words, most trading volume comes from traders that buy and sell based on intraday price movements.
The trading volume brought about by speculators is estimated to be more than 90%!
The scale of the forex speculative market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high.
This makes it very easy for anyone to buy and sell currencies.
From the perspective of an investor, liquidity is very important because it determines how easily price can change over a given time period. A liquid market environment like forex enables huge trading volumes to happen with very little effect on price, or price action.
While the forex market is relatively very liquid, the market depth could change depending on the currency pair and time of day.
In our trading sessions part of the school, we’ll tell you how the time of your trades can affect the pair you’re trading.
In the meantime, here are a few tricks on how you can trade currencies in gazillion ways. We even narrowed it down to four!