Introduction

In a simple words foreign exchange means buying of one currency and selling of another currency. Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled since 2004. The increase in turnover is due to a number of factors: the growing importance of foreign exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of retail investors as an important market segment. The foreign exchange market (FOREX) is the largest financial market in the world with 4 trillion USD daily. This is three times more than the total amount of stock and future markets combined. 24 hr market from Monday to Friday. The foreign exchange market is largely a over the counter (OTC). Here the traders sits in a office and do transactions over a telephones, telexes and other electric mean of communication. In currency market, Currencies are traded through broker and dealer & executed through currency pairs. London, New York, Tokyo are the major market centers. Others are Zurich, Frankfurt, Hong Kong & Singapore

Structure of foreign Exchange market This market is exists in retail as well as wholesale level. In the retail market for foreign exchange, travelers and tourists exchange one currency in the form of exchange notes. The total turnover of this kind of market is very small. The wholesale market is often called interbank market. The participants in these markets are commercial banks, investment banks, corporations and central banks. The total turnover in this market is very large.

CENTRALIZES MARKET STRUCTURE:

DECENTRALIZED MARKET STRUCTURE

Getting Started Why to trade foreign currencies? In todays market place, the dollar constantly fluctuate against other currencies of the world. Several factors such as, the decline of global equity markets and declining the world interest rates, have forced investors to pursue new opportunities. Which currencies are traded?

Any currency backed by an existing nation can be traded at the larger brokers. In currency market, major currencies are traded is US dollar(USD), EURO dollar(EUR), Japanese YEN (JPY), the British Pound sterling(GBP), the SWISS FRANC (CHF), The Canadian Dollar (CAD), and the Australian Dollar (AUD). And all other currencies are treated as a minor. Who trades on foreign exchange? There are two main group that trade currencies. About 5% of daily volume is from companies and governments that buy or sell products or services in a foreign country. Another 95% consists of investors trading for profit or speculations. How currency prices are determined? Currency prices are affected by variety of economical and political conditions, but probably the most important are interest rates, international trade, inflation and politically stability. Sometimes government actually participates in the FOREX market to influence the value of their currencies. Advantages of currency market 1. No commission: No exchange fees, no clearing fees, no government fees, no brokerage fees. 2. No middlemen: here client is directly access the market and sole responsible for the same. 3. low transaction cost: less than 0.1% 4. high liquidity: Forex is most liquid market in the world means trader can enter or exit in any condition of the market. 5. A 24-hr market Global FOREX market turnover Spot transactions: A spot transaction is a two-day delivery transaction. Outright Forwards: An outright forward contract allows an investor to buy or sell a currency on a specific date or within a range of dates forex swaps: FX agreement between 2 parties to exchange a set amount of 1 currency for another and, after a certain specified period of time, to give back the original amounts that swapped. 6. online access

Currency swaps: Agreement to exchange one currency with another, at a specific rate of exchange. Source: BIS- Triennial central bank survey
Market participants in currency market Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest commercial banks and securities dealers. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle. The difference between the bid and ask prices widens (for example from 0-1 pip to 1-2 pips for a currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier interbank market accounts for 53% of all transactions. From there, smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX market makers. According to Galati and Melvin, Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s. (2004) In addition, he notes, Hedge funds have grown markedly over the 20012004 period in terms of both number and overall size. Central banks also participate in the foreign exchange market to align currencies to their economic needs.

a. Banks The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. Many large banks may trade billions of dollars, daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, which are trading desks for the bank's own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for large fees. Today, however, much of this business has moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.

b. Commercial companies

An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the longterm direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

c. Central banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.

d. Forex Fixing Forex fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reflects the real value of equilibrium in the forex market. Banks, dealers and online foreign exchange traders use fixing rates as a trend indicator. The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 199293 ERM collapse, and in more recent times in Southeast Asia.

e. Hedge funds as speculators About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.

f. Investment management firms Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the number of this type of specialist firms is quite small, many have a large value of Assets Under Management (AUM), and hence can generate large trades.

g. Retail foreign exchange traders Individual Retail speculative traders constitute a growing segment of this market with the advent of retail forex platforms, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the CFTC and NFA have in the past been subjected to periodic foreign exchange scams. To deal with the issue, the NFA and CFTC began (as of 2009) imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. As a result many of the smaller and perhaps questionable brokers are now gone or have moved to countries outside the US. A number of the forex brokers operate from the UK under FSA regulations where forex trading using margin is part of the wider over-thecounter derivatives trading industry that includes CFDs and financial spread betting. There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the price obtained in the market. Dealers or market makers, by contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at.

h. Non-bank foreign exchange companies Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account). It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.

i. Money transfer/remittance companies Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange.