The foreign exchange market is an example of a decentralised market that is used specifically in trading currencies. The forex market is subject to no financial controls and is a free to trade market. Large financial institutions and banks serve as a bridge to cater to purchasers and sellers all over the world. Major currencies of the world initiated the process of starting their free trade currencies in but it was only when countries that formed a part of the industrialised world decided to make their currencies freely available to trade.
With this came the immediate need of establishing the exchange rate in terms of the value of one currency when pitted against the other. This further led to the establishment of the currency prices being quoted on a daily basis. With the inset of the computer revolution foreign exchange transactions were made possible in most parts of the world and swiftly.
Due to the forex exchange markets, the world today is truly a Global village and it is possible to do intercontinental business transactions from any corner of the world. Forex market is based on pure currency trading; the functioning of the market is based on currency price determination. The forex market is like and other trading market, for example equities or commodities.
The only difference is the medium of transaction, which is currency. You would find large business enterprises, individuals and financial institutions all buying and selling currencies and trading with them for profitability in terms of exchange rate fluctuation. Central banks of many countries could also use the forex markets as an option to off load excess reserves of a foreign currency if required and vice-versa.
Exchange rate is the main factor that determines profitability in trading. Exchange rate is subject to constant fluctuation and is determined on the basis of the demand and supply phenomenon. The exchange rate difference between two currencies is basically trading value and the size of the very currency. Currencies have a tendency to get stronger when the demand is more than the availability and vice-versa.
Other factors that influence the demand of a currency are a speculative action or an increase or decrease in business activity of the country. This the determination of the number of one units of a currency in comparison to another. For example, if you are to buy goods from country A, the purchase power ration would be the difference in the number of extra units you would have to spend or save in terms of the conversion in order to facilitate the purchase.
Forex market volumes are smaller than transactions that occur on stock markets, however the risk factor in forex trading is lesser. Changes in interest rates also have little or no effect on forex exchange rates. However in terms of volume of transaction, the forex market offers a lot of potential to earn profitability.More...