Size and Liquidity of the Forex Market

The majority of forex trading occurs within the realm of the "interbank market."

In contrast to traditional financial markets like the New York Stock Exchange (NYSE) or London Stock Exchange (LSE), the forex market lacks a physical location or central exchange.

The forex market is classified as an over-the-counter (OTC) market because it operates entirely electronically, connecting various banks and non-bank financial institutions (NBFIs) across the globe, operating continuously 24 hours a day.

This decentralized nature means that the FX market is distributed worldwide, with no centralized hub. Trades can occur from anywhere with an internet connection.

The forex OTC market ranks as the largest and most widely traded financial market on the planet, drawing participants from both individuals and organizations worldwide.

In an OTC market, participants have the flexibility to choose their trading partners based on various factors such as trading conditions, price competitiveness, and the reputation of the counterparty (the entity taking the opposite side of a trade).

Notably, the U.S. dollar leads the pack, accounting for 84.9% of all transactions. The euro follows at 39.1%, with the yen coming in third at 19.0%.

Evidently, the major currencies dominate the upper echelons of this list.

The Dominance of the U.S. Dollar in the Forex Market

You may have noticed how frequently we emphasize the significance of the U.S. dollar (USD).

Given that the USD forms one-half of every major currency pair, and these majors make up 75% of all forex trades, it's imperative to keep a keen eye on the U.S. dollar. It truly reigns supreme!

In fact, as per the International Monetary Fund (IMF), the U.S. dollar accounts for approximately 62% of the world's official foreign exchange reserves.

Foreign exchange reserves represent assets held in foreign currencies by a central bank.

Due to its widespread ownership by nearly every investor, business, and central bank, the U.S. dollar commands unwavering attention.

There are several other compelling reasons why the U.S. dollar occupies a central role in the forex market:

• The United States boasts the LARGEST economy globally.
• The U.S. dollar serves as the world's reserve currency.
• The United States hosts the largest and most liquid financial markets worldwide.
• The U.S. enjoys a stable political system.
• The United States holds the distinction of being the sole military superpower in the world.
• The U.S. dollar represents approximately half of international loans and bonds, with numerous countries and foreign companies borrowing in USD.
• The U.S. dollar serves as the medium of exchange for a multitude of cross-border transactions. For instance, oil is priced in U.S. dollars, commonly referred to as "petrodollars." Therefore, if Japan wishes to purchase oil from Saudi Arabia, it must do so using U.S. dollars. If Japan lacks sufficient dollars, it must first exchange its yen for U.S. dollars.

Essentially, the world heavily relies on a continuous supply of USD to facilitate international trade, payments, and loans.

Speculation in the Forex Market

The primary functions of the forex market include:

1. Facilitating the transfer of funds between different currencies of countries.
2. Providing short-term credit to support international trade transactions.
3. Offering a means to hedge against foreign exchange rate fluctuations, thus mitigating risk in transactions.
4. Serving as a platform for speculation.

It's worth noting that, in the forex market, although commercial and financial transactions contribute to trading volume, the majority of currency trading is driven by speculation.

In simpler terms, a significant portion of trading activity involves traders buying and selling currency pairs based on short-term price movements.

In fact, it's estimated that speculators account for over 90% of the trading volume in the forex market!

Given the vast scale of the forex market, the volume of buying and selling at any given moment is immense. This results in a high level of market liquidity, which refers to the ease with which one can buy or sell a substantial quantity of an asset with minimal impact on its price.

The increase in market liquidity since the 1970s has brought about numerous advantages.

For short-term traders, liquidity is of paramount importance because it determines how quickly prices can change within a specified timeframe.

In a liquid market like forex, substantial trading volumes can occur with minimal influence on prices or price action. However, it's worth noting that market depth can fluctuate depending on the specific currency pair and the time of day.

In our forex trading sessions, which are part of the educational curriculum, we will delve into how the timing of your trades can impact the currency pair you are trading.

For now, let's explore the various methods individuals can employ to trade currencies.