Over the Counter Markest and Liquidity
The Current market is generally and Over the Counter market, where traders transact against counter parties in an effort to receive the best possible price. The majority of the currency trading is transacted away from a regulated exchange such as futures trading or ETF trading.
A trade in the forex markets takes place on what is referred to as a currency pair. A currency pair is two currencies that trade as a security. For example, if an investor where to purchase dollars and sell the Yen, the currency pair or security is USD/JPY.
Certain currencies take precedence when paired with other currencies and it is important prior to transacting the parties to the transaction clarify the currency they are buying and selling. The currency markets perform an important function in global trade, and even more important is the liquidity that the currency market provides. Millions of transactions are completed every day in this electric and exciting market, and each trade adds to the liquidity of the market.
If very few trades take place in an instrument, then the liquidity is fair, if there are hundreds or thousands of transactions, the liquidity in a market is excellent. The current daily notional volume in the currency markets is approximately 4 trillion US dollars per day. Approximately 34% of the volume is traded in London England which is considered the central hub for the currency markets. New York trades almost half the volume of London, which is 16%, and Tokyo Japan is third with 6% of the daily volume.
The Participants
The Current market has numerous players that form a number of categories. Approximately 50% of the global daily transactions occur within the inter-bank market. The inter-bank market is an over the counter market where large institutions transact as counter parties with one another. Another level is where funds and smaller investment banks and retail traders transact. A third tier is where the daily exchange of small volume is transacted from one individual to another.
The majority of forex trading is speculative. The balance that is not speculative is made of corporations hedging exposure, funds changing one currency for another in foreign security trading, or central banks trying to control monetary issues.
The dealer or market makers create liquidity in the forex market. A market maker, is a trader that creates a market by determining where they will buy an instrument and where they will sell an instrument. The bid is where the market maker is willing to purchase a currency pair, and the offer is where the market maker is willing to sell the currency pair. The liquidity within the Foreign Exchange market has driven bid offer spreads to very tight levels. Liquidity plays a very important role within bid offer spreads. The easier it is to transact when trading a currency pair, the tighter the bid offer spread.