Is Forex the Biggest Money Market in This World (Updated May 2021)?

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Forex is a new market but has gained growing popularity because of its low initial investment and potentially high profits. However, have you ever wondered how big the market is and who are major participants in forex trading? Answers for those questions would be detailed in the article, so let’s keep reading.

Is Forex the Biggest Money Market in This World?

Definitely yes. Forex is the largest financial market in the world with a daily turnover of almost $6.6 trillion, a 23% increase from 2016. This is a result of the BIS Triennial Central Bank Survey that was conducted in April 2019 and engaged participating authorities in 53 jurisdictions. Meanwhile, according to Torsten Slok, chief economist at Apollo Global Management, the global stock market reached an all-time high of $95 trillion in November 2020 after the positive news of the coronavirus vaccine was announced. Besides, as of January 2021, ICMA (International Capital Market Association) approximates the world’s stock market capitalisation of $128.3 trillion.

Average daily trading volume in the global FX market from 1989 to 2021 (in thousands of US dollars)

Since 2010, the relative ranking of the seven most traded currencies has not changed. Typically, the US dollar remains its dominant currency status, constituting for 88% of foreign currency trades. The demand for several popular USD-based currency pairs also increased simultaneously. The share of trades with the euro, the world’s second most liquid currency, a bit expanded to one third. On the contrary, despite still holding the third position, the Japanese yen saw a marginal drop of 5 percentage points to 17% of the global turnover.

FX market turnover by currency and currency pairs in April 2021

Further, the forex market has recently witnessed a continuous rise in currencies from emerging market economies (EMEs) that were on side of approximately 25% of the global trades. Of which, the renminbi (or the Chinese yuan) retained the most traded EME currency with the market share of $284 billion, mostly exchanged with the US dollar. This is followed by the Hong Kong dollar, Korean won, Indian rupee and currencies from other EME regions.

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Although forex is considered as the new market, its trading volume still outweighs that of other financial markets for some reasons. In nature, forex trading is the act of selling one currency and simultaneously buying another for different purposes such as travel or commerce. According to IMARC Group, changes in lifestyles, rapid urbanisation and globalisation, and inflating incomes are key drivers of the global forex market. Those factors lead to a massive influx of tourists to different countries and higher demands for exotic products that encourage import/ export. Consequently, currency conversion activities would be favourably promoted.

Further, the forex market provides online trading platforms for those speculating on foreign currencies – in other words, trading currency for profit generation – 24 hours a day and within 5 days a week. Particularly, forex traders may attend four main trading sessions and conduct transactions. Meanwhile, other financial markets allow investors to trade in a certain time, for example, the stock market only opens from 1.31 PM to 8 PM GMT+0, according to FiNMAXFX.

Therefore, the forex trading volume mostly comes from spot transactions and foreign currency exchanges which turn forex the largest money market across the world.

Forex Market: Who Trade Currencies and Why

The forex market has different types of participants that include institutional and retail players.

Major Institutional Participants

The main attendees in the forex market are institutions and institutional investors who contribute approximately 95% of daily turnover to forex trading. Therefore, the forex market would be profoundly affected by the operations of those institutional participants. Besides, “institutions” are defined differently from “institutional investors”. Accordingly, the former are physical entities that directly trade foreign currencies on behalf of their own accounts, whilst the latter represents a particular organisation to enter trades.

Large International Banks

Originally, the forex market was a playground for large commercial and investment banks and only individual investors who had large capital and built a long-term relationship with banks were allowed to join in the market.

Unlike other financial markets where investors wait for financial returns from trading assets, some core functions of large banks are lending or borrowing foreign currencies to or from other banks and trading on behalf of their clients, for example, helping their clients to buy goods in a foreign currency with credit cards. This explains why the forex market is sometimes implicitly as an interbank market. 

Today, although the introduction of digital trading platforms has involved various types of participants to the market, bank dealers remain their leading status and continue to “attract large flows to their proprietary liquidity pools”, according to BIS.

Central Banks

On behalf of a country, central banks participate in forex trading, not for profits, but rather stabilising or increasing the competitiveness of the domestic economy by introducing monetary policies. Accordingly, they may affect the money supply, set interest rates on a local currency and calm inflation to make exports more competitive in global markets.

Concurrently, central banks may use foreign exchange reserves to avoid negative impacts on a local currency’s exchange rate by balancing payments to reduce external debts, maintaining a stable rate and building the confidence of investors in financial markets.

Moreover, commercial banks are heavily regulated by central banks. Therefore, all currency conversion activities are greatly influenced by issued monetary policies of central banks.

Commercial Companies                

Commercial corporations engage in forex transactions to import and export commodities or services. Also, some companies need foreign currency to pay for their employees abroad.

Another motive for those firms to enter the forex market is to hedge potential risks regarding currency conversion when they sign forward or futures contracts. For example, a US company plans to buy components of a German company and then makes payments at a predetermined date. The former may sign a currency swap agreement to hedge against price fluctuations. So, they will pay at a pre-specified price no matter what the market price is on that day.

Accordingly, currency swap transactions contribute $108.49 billion to the total forex trading volume.

Hedge Funds and Investment Management Companies

Hedge fund companies use pooled funds from investors to invest in a wide range of financial markets. Accordingly, some of them enter speculative trades in forex as a part of their investment strategy to boost financial returns for their customers no matter how the market moves.

Meanwhile, investment management companies that manage accounts on behalf of their clients, albeit institutions (e.g. pension funds or insurance companies) or individuals, execute speculative currency trades to facilitate the management of foreign securities purchases. In this way, portfolio managers need to buy and sell pairs of foreign currencies to pay for international equity.

Those organisations commission a variety of private-equity managers who are considered as “institutional investors” to enter the forex market.

Bureaux de Change

Bureaux de Change – known as currency transfer companies – are located at airports, stations and in some places around cities. Their aim is providing currency conversion services at reasonable prices to travellers who wish to swap currencies for travelling abroad.

Forex Brokerage Companies

Nowadays, individual investors entering the forex market have to open an account with brokerage companies. Apart from major market makers such as banks and large financial institutions, most forex brokers now act as dealers who join in the market as a counterparty to forex transactions. Similar to other institutional participants, brokerage companies make money by charging commission fees and spreads which are the difference between the bid (selling) price and the ask (buying price).

Retail Investors

As already mentioned, with the current support of brokers and new technologies, individual investors are allowed to start forex trading with low capital but possibly high financial returns. Accordingly, they may deposit small funds and then leverage their investments – in other words, borrow money from brokers – to open more positions. Those individuals have to comply with regulations issued by brokers such as deposit and withdrawal requirements.

Although the market has attracted an increasing number of retail participants, their market share is relatively small in comparison with institutional participants, especially central and commercial banks whose operations make big price movements. Therefore, retail traders can hardly participate in the market on weekends when those major players stay out of the market, or at least no transactions occur on a trading desk.

Conclusion

Inevitably, forex is the biggest money market in the world with the daily trading volume of $6.6 trillion which is broken down mostly into foreign currency swaps and spot transactions, followed by outright forwards, currency swaps, options and other products.

Forex is the most fast-growing and liquid market because foreign currency conversion is an indispensable part of financial activities, especially in this globalisation era when demands for foreign products and services dramatically increase.

The forex market has been highly fragmented by a diversity of participants and allowed different levels of access. Accordingly, commercial and central banks are major players that have considerable impacts on price fluctuations, followed by hedge funds, other non-financial companies and individual traders.

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