The Foreign Exchange (FX) business involves banks and investors trading different currencies. Investors in the FX market include hedge funds, which are focused on profiting from volatility in the FX markets; large asset managers, which generally trade in large volumes and take more of a long-term view to profitability; and investors that require specific currencies to make particular investments. The rise of technology means that FX is often traded through the use of algorithms and electronic platforms. The FX business involves trading currencies over the counter (OTC), which means currencies are not traded on a central exchange.
The FX business plays a fundamental role in facilitating investment in different jurisdictions and the following scenarios provide examples of the circumstances under which the FX market may come into play. Investors may need to exchange their domestic currency for the foreign currency required to make a purchase in a different jurisdiction. A parent company may need to convert revenue generated by a subsidiary operating in a different region (assuming goods or services have been purchased using a different currency) into the currency used in the parent company’s primary jurisdiction. Accordingly, the FX desk in a bank is likely to service a multitude of clients, rather than only clients from particular sectors.
Foreign exchange (FX) is the largest and most liquid market in the world. The liquidity of the market is advantageous for investors, as liquidity indicates there is ample opportunity to purchase or sell currencies (and thus investors will not end up stuck with an investment, unable to trade out of their position). Unlike the equities markets (which have set daily opening hours), the FX market is open 24 hours a day, 5 days a week. London is the main global hub for FX trading, although other major hubs include New York, Zurich, Tokyo, Frankfurt and Sydney. Some of the most traded currencies are the USD (United States Dollar), EUR (Euro), JPY (Japanese Yen), GBP (Pound Sterling), AUD (Australian Dollar) and the CHF (Swiss Franc).
Currencies are always quoted in pairs, as the price of any currency must be given relative to another currency. If you see GBP/USD = 1.70, this means the GBP is being used as the base currency and 1 GBP is currently worth 1.70 USD in the market.
- Cable: this is the term used traditionally to describe the GBP/USD pair on the trading floor. If a trader says: “I am long cable”, this means that they believe the USD will depreciate in value relative to the GBP (meaning 1 GBP will in the future be worth more than 1.70 USD).
The FX market is driven by macroeconomic events. FX teams will generally focus on economic data such as the statistics discussed in the Introduction To Economics: Macroeconomics section when making trading decisions, in addition to other factors such as political events. However, there are often situations in which the FX market does not react as predicted and thus there is still an element of risk underpinning the decisions of FX teams.
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By Jake Schogger - City Career Series