Average daily currency trading
volumes exceed $2 trillion per day. That's a mind-boggling number isn't it?
$2,000.000, 000,000 - that‘s a lot of zeros, no matter how you slice it. To
give you some perspective on that size, it‘s about I0 to l5 times the size of
daily trading volume on all the world‘s stock markets combined. That $2-trillion-a-day
number, which you may’ve seen in the financial press or books on currency
trading, actually overstates the size of what the , forex market is all about -
spot currency trading.
Trading for spot
Spot refers to the price where you can buy or sell currencies now, as in “on the spot." lf
you’re familiar with stock trading, the price you can trade at is essentially a
spot price. Technically, the term refers to the nearest settlement date on
which a transaction can be made and is primarily meant to differentiate spot,
or cash, trading from futures trading, or trading for some future delivery
date. The spot currency market is normally traded for settlement in two
business days.
The Bank for International Settlements
(BIS), the international supervisory body for banks around the world, surveys
forex market volumes every three years. The 2004 BIS survey revealed a daily
spot trading volume of about $620 billion, with another $100+ billion in
estimated gaps due to reporting. The rest of the volume that makes up the $2
trillion figure is comprised of swap and outright forward currency trading
(trades made for settlement dates other than spot).
Speculating the currency market
While commercial and financial
transactions in the currency markets represent huge nominal sums, they still
pale in comparison to amounts based on speculation. By far the vast majority of
currency trading volume is based on speculation traders buying and selling for
short-term gains based on minute-to-minute, hour-to-hour, and day-to-day price
fluctuations.
Estimates are that upwards of 90%
of daily trading volume is derived from speculation (meaning, commercial or
investment-based FX trades account for less than 10% of daily global volume).
The depth and breadth of the speculative market means that the liquidity of the
overall forex market is unparalleled among global financial markets.
The bulk of spot currency trading,
about 75% by volume, takes place in the so-called “major currencies,"
which represent the world’s largest and most developed economies. Trading in
the major currencies is largely free from government regulation and takes place
outside the authority of any national or international body.
Additionally, activity in the
forex market frequently functions on a regional “currency bloc" basis,
where the bulk of trading takes place between the USD bloc, JPY bloc, and EUR
bloc, representing the three largest global economic regions.
Trading in the currencies of smaller,
less-developed economies, such as Thailand or Chile, is often referred to as emerging market or exotic currency trading and may involve currencies with local
restrictions on convertibility or limited liquidity, both of which limit access
and inhibit the development of an active market.
Getting liquid without getting soaked
Liquidity refers to the level of market interest - the level of buying
and selling volume which is available at any given moment for a particular
asset or security. The higher the liquidity, or the deeper the market, the
faster and easier it is to buy or sell a security.
From a trading perspective, liquidity is a critical consideration
because it determines how quickly prices move between trades and over time.
A highly liquid market like forex can see large trading volumes transacted with
relatively minor price changes. An illiquid, or thin, market will tend to see
prices move more rapidly on relatively lower trading volumes. A market that
only trades during certain hours (futures contracts. for example) also
represents a less liquid, thinner market.
I refer to liquidity, liquidity
considerations and market interest because they're among the most important
factors affecting how prices move or price action.
It's important to understand that,
although the forex market offers exceptionally high liquidity on an overall
basis, liquidity levels vary throughout the trading day and across various
currency pairs. For individual traders, though, variations in liquidity are more
of a strategic consideration rather than a tactical issue. For example, if a
large hedge fund needs to make a trade worth several hundred million dollars,
it needs to be concerned about the tactical levels of liquidity, such as how
much its trade is likely to move market prices depending on when the trade is
executed. For individuals, who generally trade in smaller sizes, the amounts
are not an issue, but the strategic levels of liquidity are an important factor
in the timing of when and how prices are likely to move.
