Size and liquidity of the foreign exchange market

Hello and welcome to lesson number four with Robbie Garnier from TradeFxP. Today we're going to look at the size and liquidity of the forex market. Let's dive in.

Jump! It's very liquid!

The majority of foreign exchange trading takes place on the interbank market. This market differs from other financial markets, such as the New York Stock Exchange or the London Stock Exchange, because it doesn't have a physical location or a central exchange. It's a decentralized market, which means that it's not in the hands of a single company. The foreign exchange market operates as an over-the-counter (OTC) market that is conducted electronically around the clock in a network of banks and non-bank financial institutions (NBFIs).

This 24-hour operation means that the foreign exchange market is global and there is no central hub. You can trade from anywhere with an internet connection. It's the largest and most popular financial market in the world, with a wide range of individuals and organizations participating.

In an over-the-counter market, traders have the flexibility to choose their trading partners based on the terms, price attractiveness, and reputation of the counterparty. The US dollar dominates the market with 84.9% of all transactions, with the euro in second place at 39.1% and the yen in third place at 19%. The most important currencies occupy the top positions, with the dollar dominating.

The International Monetary Fund reports that the US dollar accounts for around 62% of the world's official foreign exchange reserves. However, the BRICS countries and the expanding economies in Asia are challenging the dominance of the US dollar.

Nevertheless, the US dollar remains the world's reserve currency, primarily because the United States has the largest economy. The US also has the most liquid financial markets, a stable political system, and is considered the only military superpower. In addition, the US dollar is used for half of all international loans and bonds and serves as a medium of exchange for many cross-border transactions, e.g., in the oil trade.

However, with countries such as Saudi Arabia joining the BRICS, there could soon be an alternative to the petrodollar system.

Now let's talk about the functions of the foreign exchange market. It facilitates the transfer of money between the currencies of different countries, provides short-term credit for international trade, offers protection against exchange rate fluctuations, and enables speculation.

It's important to note that while there are commercial and financial transactions, the majority of trading volume is speculative. Traders buy and sell based on short-term price movements, and this speculative trading accounts for over 90% of the total volume.

The huge size of the foreign exchange market ensures high liquidity, meaning large volumes can be traded with minimal impact on price. This is an advantage for short-term traders, as prices on the market are easy to move. However, the depth of the market can vary depending on the currency pair and time of day.

In our next forex trading sessions, we'll discuss how the timing of your trades can affect the currency pair you're trading. For now, let's reflect on what we've learned today.

I'm Robbie Garnier from TradeFxP, and I'm signing off. I'll see you in the next class. Good luck!