Market Size and Liquidity
Unlike other financial markets like the New York Stock Exchange, the Forex market has neither a physical location nor a central exchange. The Forex market is considered an Over-the-Counter (OTC), or “Interbank” market because the entire market is operated electronically within a network of banks that run continuously 24 hours a day, 5 days a week. This means that the spot Forex market is spread all over the globe with no central location. Traders can access this market from anywhere in the world with a computer and internet connection.
The Forex OTC market is by far the largest and most popular financial market in the world because it is traded globally by a large number of individuals and organizations. In the OTC market, participants determine who they want to trade with depending on trading conditions, attractiveness of prices, and reputation of the trading counterpart. In the case of the retail traders the counterparty would be a forex brokerage. The chart below shows the ten most actively traded currencies.
The dollar is the most traded currency, taking up 84.9% of all transactions. The euro’s share is second at 39.1%, while that of the yen is third at 19.0%. As you can see, most of the major currencies are occupy top spots on this list.
An image of the currency distribution in the FX market.
The chart above shows just how often the U.S. dollar is traded in the Forex market. It is on one side of 84.9% of all reported transactions. This is likely due to the fact that the US dollar is the currently the world reserve currency and one of the largest importer or goods from other countries. This means that many companies outside of the United States must buy dollars to trade and sell their goods to the US.
The Dollar is King in the Forex Market. If the USD is one half of every major currency pair, and the majors comprise 75% of all trades, then Forex traders should pay attention to the U.S. dollar.
An image of the currency composition of world FX reserves.
In fact, according to the International Monetary Fund (IMF), the U.S. dollar comprises roughly 62% of the world’s official foreign exchange reserves. Because almost every investor, business, and central bank owns it, they pay close attention to the U.S. dollar.
There are also other significant reasons why the U.S. dollar plays a central role in the Forex market such as:
- The United States economy is the largest economy in the world.
- The U.S. dollar is the reserve currency of the world.
- The United States has the largest and most liquid financial markets in the world.
- The United States has a stable political system compared to other countries.
- The United States is the world’s sole military superpower.
- The U.S. dollar is the medium of exchange for many cross-border transactions. For example, oil is priced in U.S. dollars. So if Mexico wants to buy oil from Saudi Arabia, it can only be bought with U.S. dollar. If Mexico doesn’t have any dollars, it has to sell its pesos first and buy U.S. dollars.
Speculation in the Forex Market
One important thing to note about the Forex market is that while commercial and financial transactions are part of trading volume, most currency trading is based on speculation. In other words, most trading volume comes from traders that buy and sell based on intraday price movements. The trading volume brought about by speculators is estimated to be more than 90% of the total transacted volume!
The scale of the Forex market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high. This makes it very easy for anyone to buy and sell currencies.
From the perspective of an investor, liquidity is very important because it determines how easily price can change over a given time period. A liquid market environment like Forex enables huge trading volumes to happen with very little effect on price, or price action.
While the Forex market is relatively very liquid, the market depth could change depending on the currency pair and time of day. The liquidity for specific currencies tend to have the most volume traded when that country’s stock market is open because money is actively trading hands during the specific country’s business hours.
Related Wikis
Readers of Forex Market Size and Liquidity also viewed: