The currency exchange market is the reason that we’re all here at Travelex. Also known as the foreign exchange market, the forex market or even just as the FX market, the currency exchange market is the largest trading market in the world and operates 24 hours a day from 10pm GMT on Sunday through to 10pm GMT on Friday.
To put it simply, foreign exchange is the act of changing one currency into another currency, whether that’s for tourism or for commerce, for your jaunt to Paris or for multimillion dollar deals.
Currency trading on the forex market sits at the heart of all things foreign currency. Here’s a little bit more about exactly how it works.
An introduction to buying and selling currency
If you’ve ever been on vacation and used a currency other than US dollars, then you’ve been part of a foreign exchange transaction on the currency market. Let’s say you were headed to London and so you needed some British pounds to take with you, £500 maybe. Wherever you went to exchange your money, you would have sold your US dollars (around $770 of them) and, in exchange, you would have bought £500. This is exactly the same way that banks and other financial institutions buy and sell in the current forex trading market, but they’re doing it with huge amounts like £500 million, instead of £500. Simple, right?
In exactly the same way, when you return from your vacation with a few leftover pounds (if you’re lucky!), you’ll probably stop by a currency exchange place and exchange your pounds back to dollars. You might notice that the exchange rates have changed from when you bought your pounds before your trip. This difference between the price you bought the currency for and the price you sold it for – the buy and sell rate known as a PIP (price interest points) – is how you make money in the foreign exchange market.
When you begin to think about buying currency as a product (as opposed to thinking about it as swapping one currency for another), the forex market falls into place.
Those at the top of the FX market (those with the most money to trade, such as investment banks) stand to make huge profits on their transactions through PIPs. Just like any other product in the world, a high demand for a currency will intrinsically mean a higher price, and this is where currency trading rates come into play.
Exchange rates and the value of a currency
The price of anything that can be bought will be influenced by its popularity and its demand. In terms of currency, this could mean that one day you could pay $770 for your £500 vacation money, but pay $775 for the same amount of pounds the week after if its demand has gone up.
The value of a currency depends on a few different things, such as that country’s economy and its business activities. If a country has a good level of employment, for instance, people will likely have more disposable income to spend on products and services, will increase gross domestic product (GDP), and, as a result, will increase the value of their country’s currency. Another factor to consider is speculation, when it's predicted that the price of a currency will increase and so lots of people start buying more of it, thereby actually increasing demand for it themselves.
The world’s major currencies are the US dollar, the euro, the Japanese yen, the British pound, the Swiss franc, the Canadian dollar, the Australian dollar and the New Zealand dollar, and these are the most traded and trusted currencies on the currency exchange market.