Understanding the Forex Market and its Participants

The forex market is the largest financial market in the world. The forex market has an average daily turnover of more than $6.6 trillion according to a BIS report in 2019. The same report also stated that the daily trading volume of forex in Singapore is more than half a trillion USD. The size of the global forex market has only been increasing every year.

Singapore is the largest forex exchange hub in Asia and the third-largest in the world after London and New York.

Similar to other financial markets, the exchange rate between different currencies depends on demand and supply, amongst other factors. The price of a currency moves upwards if there are more people buying the currency than those selling the currency.

The forex market is an example of a decentralized market. This means that there is no central control over the market. The decentralized nature of the market makes it possible for traders and investors to deal directly with each other rather than rely on a central exchange.

The global forex trading market is open at all hours during weekdays. It is closed during the weekends. This 24/5 system makes it convenient for traders from all around the world to trade with each other. However, the liquidity for particular currency pairs is different at different times of the day. In hours of low liquidity, the spreads can become wider.

People from different time zones interact and make the market run for 24 hours a day. However, the forex market can be divided into four main time zones. These different time zones correspond with the Australian market, the United States market, the European market, and the Japanese market.

There are several participants that contribute to the forex market in different ways. Some of the most major players in the market include the banks (both central and commercial), worldwide governments, large multinational companies, retail investors and traders, investment management firms, brokers and dealers, money-transfer and money-exchange companies, and so on.

For example, as a retail trader, you can use a bank to convert your currency from SGD to USD. There can be different purposes for making the exchange including travel and business needs.

How Are Currencies Traded and the Various Forex Instruments

Forex is traded in pairs. For example, a currency pair is SGD/USD. This currency pair allows you to buy or sell SGD in exchange for USD. There are numerous currency pairs operating in the global forex market.

However, forex traders should know that the USD is the most traded currency in the world. Most of the popular currency pairs in the world involve the USD. For example, EUR/USD is the largest traded currency pair.

Currency pairs can be traded through a variety of financial instruments. A financial instrument denotes the type of contract through which you are making the trade. Different financial instruments include spot forex contracts, forward contracts, contracts for difference, and so on.

We have briefly covered each financial instrument here:

Spot forex contract – A spot forex contract is the most widely used instrument for forex trading. This is the traditional way in which forex trading is and was done. A spot forex contract allows currencies to be exchanged immediately. The delivery and settlement of the contract are done instantly.

Futures forex contract – This is a more complicated derivative contract. A futures forex contract allows you to deliver and settle your trade at a later date. The prices are agreed upon beforehand. A futures forex contract allows you to take advantage of future price movements in the present.

Currency swaps – A currency swap allows traders to exchange their loan denominated in one currency for a loan denominated in another currency. This is why it is called a “swap”. A swap allows you to repay the principal amount and interest amount in a different currency. Any one of the two parties involved in a currency swap will earn profits.

Currency Forward – A forward contract allows you to exchange one currency for another at a future date, however, the exchange rate is determined at the present. This allows for future exchanges while negating the effect of price movements in the forex market. This type of contract is most often used for international trades.

Options forex contracts – An option contract provides the buyer with the right, but not the obligation, to exchange currency at a later date at a predetermined exchange right. The buyer does not have to exchange the currency on the future date, but they can. For this right, the seller is paid a premium at the time of making the contract.

Non-deliverable forward (NDF) – A non-deliverable forward allows a buyer and a seller to settle a currency exchange without actually exchanging any currency. This is why the term “non-deliverable” is used. A Non-deliverable forward is the same as a forward contract, with the exception that the actual currency is never exchanged.

CFDs – A CFD, also known as a contract-for-difference, allows forex traders to trade on price movements of the currency. Under this type of contract, only the price difference between the opening and the closing of the contract needs to be paid. There is no physical exchange of one currency in return for another.

What is Online Forex Trading and How Does it Work?

Online forex trading allows retail traders (also known as individual traders) to trade currencies and profit from price movements in the currency market. These brokers offer trading on forex pairs as a CFD. Online forex trading is gaining in popularity around the world since it provides traders with access to a highly liquid and volatile market.

Forex traders can trade online by taking advantage of the high leverage provided by global online forex brokers. Online forex trading can be done through a variety of financial instruments (as detailed above) but the most commonly used instrument is CFD. CFDs allow traders to only pay the difference in price and the actual currency does not need to be exchanged.

Online forex trading via CFDs is the least complicated. The easy availability of leverage makes it much more lucrative. You only need to make a small minimum deposit into an online brokerage account in order to get started. You can trade using margins, which means that your deposited amount only needs to cover the difference between the trades. High leverage can assist in booking bigger profits with smaller deposits. However, leverage also increases the risk factor as clients can lose the whole amount kept in the trading account.

Online CFD trading is done through trading platforms like MetaTrader 4. These trading platforms offer an easy way to keep track of price movements of different currencies and to execute trades. Online forex brokers offer a trading platform for free to their users.

There are several online forex brokers in the world these days. Over the last decade, the popularity of online forex trading has grown exponentially. The demand for forex brokers is increasing due to the ease of accessibility in CFD trading.

For example, a trader in Singapore just needs to open an account with a MAS-regulated forex broker such as CMC Markets or Plus500. To open an account, they need to complete certain KYC formalities and provide a deposit amount. Once the account is registered, the trader can download the trading platform and start trading.

Pips: A pip is the smallest movement that the price of a currency can have. For USD-related currency pairs, the value of a pip is $0.0001. The spread that you will be charged for trading a currency pair is denoted in pips.

Leverage: Leverage is a debt taken from liquidity provider to trade CFDs. A leverage ratio of 1:5 means that clients can open a position worth $500 with $100 in the account. The higher the leverage, the larger the trade that you can make with a given amount of money.

Leverage increases the potential profit you can make through your trades since you only need a fraction of the money to be able to enter a sizeable trade. However, this also increases the amount of risk that you face with your trades. For the MAS-regulated forex broker, the maximum leverage is capped at 1:20 for the retail clients.

Bid Price: The bid price is the highest price that a buyer is willing to pay for one unit of the underlying asset. In forex, the bid price refers to the amount of quote currency needed to buy or sell one unit of the base currency.

Ask Price: The ask price is the lowest amount that a seller is willing to pay to sell a security. In forex, the ask price refers to the amount of quote currency that you will need to sell in order to get one unit of the base currency.

Spread: The spread is essentially a fee levied by a forex broker. It is denoted as the difference between the bid price and the ask price. The difference between the two is the fee that the broker or liquidity provider is charging in order to provide brokerage services.

The spread is usually variable in nature. This means that the spread fluctuates in accordance with the liquidity and the timing of the trade.

The spread for trading each currency pair will be different. Usually, major currency pairs have tighter spreads than minor currency pairs. This means that trading major currency pairs is more affordable than trading other types of currency pairs.

For example, the below screenshot shows the spread for EUR/USD at XM. Their spread with Micro Account is 1.9 pips on their MetaTrader platform.

Lot sizes: Lot size is the amount of currency that you will be trading. There are three different main lot sizes in the forex market.

The three sizes are Standard, Mini, and Micro.

A Standard lot is equivalent to 100,000 units of the base currency.

A Mini lot is equivalent to 10,000 units of the base currency.

A Micro lot is equivalent to 1,000 units of the base currency.

Different brokers offer different types of lot sizes, however, the terminology for the three main types of lots largely remains the same.