The breadth, depth, and liquidity of the market are truly impressive. It has been estimated that the world's most active exchange rates like EURUSD and USDJPY can change up to 18,000 times during a single day.
Somewhere on the planet, financial centers are open for business, and banks and other institutions are trading the dollar and other currencies, every hour of the day and night, aside from possible minor gaps on weekends. In financial centers around the world, business hours overlap; as some centers close, others open and begin to trade.
The foreign exchange
market follows the sun around the earth. Each business day arrives first
in the Asia-Pacific financial centers; first Wellington, New Zealand,
then Sydney, Australia, followed by Tokyo, Hong Kong, and Singapore. A
few hours later, while markets remain active in those Asian centers, trading
begins in Bahrain and elsewhere in the Middle East. Later still, when
it is late in the business day in Tokyo, markets in Europe open for business.
Subsequently, when it is early afternoon in Europe, trading in New York
and other U.S. centers starts. Finally, completing the circle, when it
is middle or late afternoon in the United States, the next day has arrived
in the Asia-Pacific area, the first markets there have opened, and the
process begins again.
1. Spot rate
A spot transaction
is a straightforward (or outright) exchange of one currency for another.
The spot rate is the current market price or 'cash' rate. Spot transactions
do not require immediate settlement, or payment 'on the spot'. By convention,
the settlement date, or value date, is the second business day after the
deal date on which the transaction is made by the two parties.
In the foreign exchange market (and essentially in all markets) there is a buying and selling price. It is important to perceive these prices as a reflection of market condition.
A market maker is expected to quote simultaneously for his customers both a price at which he is willing to buy (the bid) and a price at which he is willing to sell (the ask) standard amounts of any currency for which he is making a market.
the difference between the bid and ask rates reflect the level of liquidity
in a certain instrument. On a normal trading day, the major currency pairs
EURUSD, USDJPY, USDCHF and GBPUSD are traded by a multitude of market
participant every few seconds. High liquidity means that there is always
a seller for your buy and a buyer for your sell at actual prices.
Every foreign exchange transaction involves two currencies. It is important to keep straight which is the base currency and which is the counter currency. The counter currency is the numerator and the base currency is the denominator. When the counter currency increases, the base currency strengthens and becomes more expensive. When the counter currency decreases, the base currency weakens and becomes cheaper. In telephone trading communications, the base currency is always stated first. For example, a quotation for USDJPY means the US dollar is the base and the yen is the counter currency. In the case of GBPUSD (usually called 'cable') the British pound is the base and the US dollar is the counter currency.
4. Quotes in terms of base currency
Traders always think
in terms of how much it costs to buy or sell the base currency. When a
quote of 0.9150 / 53 is given that means that a trader can buy EUR against
USD at 0.9153. If he is buying EURUSD for 1'000'000 at that rate he would
have USD 915'300 in exchange for his million Euro. Of course traders are
not actually interested in exchanging large amounts of different currency,
their main focus is to buy at a low rate and sell at higher one.
5. Basis points or 'pips'
For most currencies, bid and offer quotes are carried down to the fourth decimal place. That represents one-hundredth of one percent, or 1/10,000th of the counter currency unit, usually called a 'pip'. However, for a few currency units that are relatively small in absolute value, such as the Japanese yen, quotes may be carried down to two decimal places and a 'pip' is 1/100th of the terms currency unit. In foreign exchange, a 'pip' is the smallest amount by which a price may fluctuate in that market.
6. Euro cross & cross rates
Euro cross rates are
currency pairs that involve the Euro currency versus another currency.
Examples of Euro crosses are EURJPY, EURCHF and GBPEUR. Currency pairs
that involve neither the Euro nor the US dollar are called cross rates.
Examples of cross rates are GBPJPY and CHFJPY. Of course hundreds of cross
rates exist involving exotic currency pairs but they are often plagued
by low liquidity. Ever since the Euro the number of liquid cross rates
have decreased and have been replaced (to a certain extent) by Euro crosses.
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