What is the FOREX

[nigelforbes]

A number of posters recently have said they don't understand how the FOREX or foreign exchange works, maybe this will help:

 

What is The FOREX?

 

There are three FOREX markets, Spot, Forward and Future. This explanation deals only with the Spot Market which is the everyday foreign currency exchange mechanism used by most people.

 

The FOREX is a series of algorithms that show the relative value of one currency against other currencies. When one currency strengthens or weakens, the FOREX provides the means to adjust the relative value of that currency, against all the others, and vice versa.

 

The FOREX is operated by member banks, dealers and central banks and anyone else who is capable of becoming a FOREX member.

 

The FOREX is immediate and real time, it is over the counter (OTC) so there is no delay or reference to a central body for approval.

 

The FOREX system is regional. Global coordination is conducted by Thompson/Reuters but The 4pm London Fix ensures global uniformity.

 

What is it NOT?

 

It is not centrally operated.

 

It is not owned or operated by a Central Bank (who are only member's of FOREX just like all other members)

 

The Typical 24 Hour Cycle of one Currency

 

Banks, Dealers Brokers and consumers trade currency 24 hours a day globally. The value of all currencies is expressed in currency pairs, most commonly against the value of Reserve Currencies such as USD, GBP, EUR etc. The value of the Thai Baht for example is often shown against USD in the format, THB/USD which shows how much of the second currency pair can be bought for one unit of the first pair.

 

The process of buying and selling currency pairs often involves millions of transaction per second. The more that one currency is bought against a Reserve Currency, the stronger that currency becomes, the more it is sold, the more it weakens. The process of determining the value of a currency whilst millions of transactions are taking place every second, is the responsibility of FOREX. The FOREX continuously aggregates all the transactions in real time to see what the net effect is of all the plus and minus movements, on a currency value. The difference in total value of all those transactions results in a change in currency value that is either positive or negative.

 

The FOREX displays the latest known value for a currency pair which is known as the Spot Value, this is the value before any buying or selling commissions or fees have been applied. The Spot Value can change every second. The FOREX adjusts the spot value in PIPS (Percentage in Point), in real time, the smallest possible movement of a currency according to the netting procedure which is ongoing. As one currency increases or reduces in value against a Reserve Currency, the FOREX adjusts the relative value of related currencies accordingly. The movements in currency values are almost identical to the movement in stock and shares on the stock markets. They are constantly changing based on demand and based on latest news of events that effect their movement and as their individual value changes, so the value of the indices change.

 

If for example somebody wants to buy or sell a currency they must look to see what price is being offered, if they are unhappy with it they can make a counter offer. Eventually a strike price is agreed and the trade is agreed, obviously, the more money that is involved, the greater the opportunity to influence the value of the trade. The agreed price between dealers/banks/brokers is known as the strike price and is the absolute value of that pair, at that moment in time. Currency Dealers remain acutely aware of the factors that determine currency value and any bid to buy or sell a pair will be influenced by these factors, just in the same way that the value of stocks and shares are influenced by latest economic and political data. In this respect it is the Dealers Banks and Brokers who agree the value of a currency pair, at any point in time, if the Central Bank disagrees with their interpretation, it must intervene in markets to influence the value by buying and selling currency, just like any one else. Key factors that dealers/banks will consider that effect the value of exchange rates include: inflation levels, interest rates, current account value, conditions of trade (balance of trade and trading account value), economic performance and public debt (not consumer debt).

 

Consumers who approach a currency exchange booth in the street will be given an exchange rate according to the value shown by their FOREX supplier, plus or minus any commissions. The FOREX supplier may be a bank who in turn is connected to a currency dealer so their may be several layers involved.

 

Throughout the day the Central Bank monitors the exchange rate to ensure it is within the range they want. If it isn’t they can intervene and buy and sell currency just like anyone else, selling local currency against USD to make it weaker or buying it to make it stronger. Each day the Central Bank will look at the volume of currency transactions that have taken place during the previous 24 hours and also at the prevailing exchange rate. If they are happy with those things, nothing happens, if they are not, they can intervene in markets. This almost theoretical once a day look at the exchange rate is known as the daily fix. It is nothing more than a sign off that the bank agrees with the value of the currency, at that that point in time, in light of the recent activity.

 

The 4pm London Fix

 

The global check and balance in the FOREX is the London Fix.

 

“The closing currency “fix” refers to benchmark foreign exchange rates that are set in London at 4 p.m. daily. Known as the WM/Reuters benchmark rates, they are determined on the basis of actual buy and sell transactions conducted by FOREX traders in the interbank market during a 60-second window (30 seconds either side of 4 p.m.).The benchmark rates for 21 major currencies are based on the median level of all trades that go through in this one-minute period”.

 

https://www.investopedia.com/articles/forex/031714

 

Following the London Fix the relative values of key currencies can be adjusted, in theory by negligible amounts.

[nigelforbes]

53 minutes ago, Chivas said:

lol 75% here simply dont understand how Sterling/Baht Euro/Baht AUD/Baht etc was calculated prior to your post

 

Make that 99% now....

 

In your own words it wasn't an explanation of how to trade forex

 

For Christs sake if you're a Brit its simply (Sterling/Dollar) x (Dollar/Baht)

 

If you're holding AUD or Euro (or whatever) substitute that to where Sterling is above in the equation.....simple as that

 

End....

 

(PS nice copy and paste)

I wrote the opening post to try and help posters understand how the global forex system works, not how to trade forex or to understand how the value of GBP/THB is derived. I invite anyone to run any part of my post that is not in quotes, through any plagarism checker, you wont find any part of it written elsewhere.

 

The opening post is not about how to trade forex. The post is about how FOREX works, there is a big difference. 

 

You keep telling everyone that the value of GBP/THB comes from USD/THB and USD/GBP, what you fail to tell everyone is where the value of USD/THB and USD/GBP comes from in the first place! Where it comes from is through the aggregation of millions of buy and sell USD/THB, THB/USD, USD/GBP and GBP/USD transactions every second. They translate into PIP adjustments to the value of GBP and THB and other  currencies in the FOREX tree, using the algorithms contained in FOREX. That's where GBP/THB comes from, not from any multiplier and certainly NOT from any Central Bank fix.

Edited October 14, 2022 by nigelforbes

[nigelforbes]

Currency pairs can be divided in major, minor, exotics and cross pairs. There are about seven major currency pairs, all involving USD that is paired with another currency; seven minor currency pairs involving other reserve currency pairs, and exotic currency pairs which pair USD against a minor currency such as THB. In addition, any currency that is not paired with USD directly is referred to as a cross pair, GBP/THB is an example of a cross pair albeit a minor cross pair because THB is relatively small in FOREX currency terms.

 

Before the value of any cross pair can be calculated, say GBP/THB for example, the value of GBP and THB (or the other components of the cross) against USD must be calculated separately. The value of THB can be determined by the net value of all USD/THB and THB/USD trades over a given period and this is what the FOREX does so this part is simple because USD/THB is NOT a cross pair.

 

Establishing the value of USD/GBP is slightly more complex because the value of USD itself is determined in part by the value of five base currencies, one of which is GBP, along with all the other usual factors that determine a currency value. Nevertheless, USD/GBP is not a cross pair and the FOREX can determine the net value of all trades to establish the value of GBP. Currencies that determine the value of the US Dollar Index include the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. You can see from this that any change in the relative value of GBP impacts not only the value of GBP cross pairs but also the value of USD itself.

[nigelforbes]

Let me wrap up this explanation with some misc. FOREX market trivia:

 

Daily turnover of the global FOREX is about USD 6.6 trill and is increasing at about 40% per decade.

 

As of 2019, the most traded currency was USD which amounted to over 88% of all traded volume, GBP amounted to about 13% whilst THB amounted to 0.5%. Note: total volume must equal 200%.

 

The Spot price is the market price, the Bid Price is the highest price a buyer will pay, the Ask Price is the lowest Price a seller will sell.

 

The rules of the FOREX Wholesale market are set out in the FX Global Code. The FX Global Code is a set of principles of good practice for foreign exchange market participants. It aims to promote the integrity and effective functioning of the wholesale foreign exchange market.

 

The founder of Forex trading is typically credited to be a man by the name of Richard D. Wyckoff, who created the Wyckoff Stock Market Institute.

 

The FOREX software uses a proprietary scripting language, MQL4/MQL5, which enables traders to develop Expert Advisors, custom indicators and scripts.

 

The software used in the FOREX is called MetaTrader 4, also known as MT4, is an electronic trading platform widely used by online retail foreign exchange speculative traders. The software is owned by Metaquotes Software Co.

 

As the bankers' bank, the Bank of International Settlements (BIS) serves the financial needs of member central banks. It provides gold and foreign exchange transactions for them and holds central bank reserves. The BIS is also a banker and fund manager for other international financial institutions. The BIS is the mechanism used to settle claims between Central Banks for related FOREX activity which are netted daily.

 

One of the key roles of BIS in the FOREX market is to monitor the risk assumed by member banks and to ensure FOREX market quotes are balanced globally. The following note from the BIS website explains:

 

“The purpose of this note is to consider the prudential aspects of banks' foreign exchange activities. It is not directly concerned with the restrictions that countries may place on their banks' foreign exchange business for exchange control, monetary or other macro-economic reasons. In exercising prudential control over this area of banks' activities, however, supervisory authorities need to take into account the role of the banks as "market-makers" in foreign exchange. This role has two aspects. Firstly, banks have to quote rates to their customers (including other banks) at which they stand ready to buy and sell currencies. Secondly, by themselves taking open positions in currencies, banks (as well as non-banks) help to ensure that the foreign exchange markets are balanced at any point of time without excessive and erratic exchange rate fluctuations. In other words, supervisors have to weigh prudential considerations against the need to enable the banks to play their part in the smooth and efficient functioning of the exchange markets. Whatever may be the exact balance struck between these considerations, supervisory authorities must seek to ensure that the risks assumed by banks in their foreign exchange operations are never so large as to constitute a significant threat either to the solvency and liquidity of individual banks, or to the health and stability of the banking system as a whole”.

 

https://www.bis.org/publ/bcbs00e.htm

 

 

 

[nigelforbes]

A recent exchange with another poster prompted me to post an explanation of how the value of USD is reported for FOREX purposes. The following extract from Marketwatch explains nicely:

 

"There’s a number of ways to judge the dollar’s performance and one of the most common is by using the ICE U.S. Dollar Index, which is calculated about every 15 seconds from a feed of spot prices on different currencies. Six currencies — the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc — are weighted against the dollar to come up with a calculation of how the U.S. currency is performing".

 

https://www.marketwatch.com/story/the-u-s-dollar-continues-to-soar-what-that-means-for-the-stock-market-and-investors-11666208052?siteid=yhoof2

 

There are a number of ways to assess the value of USD and each one has its place. The Dollar Index reports on the strength or weakness of USD in a FOREX context; the volume of Treasury notes issued by the Fed measures it on a credit basis whilst Foreign Currency Reserves asses USD strength from a trading perspective. It's only necessary to understand the Dollar Index to asses the current value of USD, the remaining two ways are used to determine the future direction of the currency.

[nigelforbes]

6 minutes ago, Sparktrader said:

Wise has multi currencies. The aud went to 1.1usd now 0.61. Safe play if you can hold.

 

St trading more risky.

Please do not turn this thread into a discussion about how to trade FOREX for personal benefit, it's not about that. Thanks

[nigelforbes]

1 minute ago, Sparktrader said:

Buying and holding usd for 3 or 4 years isnt trading.

 

Its an investment.

This thread is not about FOREX investments either, as you well know! It's purpose, as stated in the first post, is to help posters understand how the FOREX operates at the global level and all that involves. Now please!

[Rimmer]

Some off topic posts about trading have been removed, the topic is about helping posters understand how the global forex system works, not how to trade.

 

From the OP:

A number of posters recently have said they don't understand how the FOREX or foreign exchange works, maybe this will help:

 

What is The FOREX?