How Does the Foreign Exchange Market Work?

By Stock Research Pro • May 22nd, 2009

The foreign exchange market is a global network of dealers and financial institutions that connects buyers and sellers of currencies. Participants in the foreign exchange market include governments, corporations, banks and other financial institutions, and individuals. These participants leverage the network to communicate their currency needs and initiate and settle transactions. While the currency price is set at the time of the transaction, settlement can occur at some point in the future.

Size and Participation in the Foreign Exchange Market

Comprising hundreds of thousands of individuals, governments, and financial institutions, foreign exchange includes more participants than any other market. One of the key features of foreign exchange is that prices are identical everywhere in the world (this consistency eliminates easy opportunities for arbitrage). Daily turnover in the major segments of the market is close to $2 trillion, making it about 40 times larger than the New York Stock Exchange.

Major Segments of the Foreign Exchange Market

The primary segments of the foreign exchange market include:

Spot: The market that completes the transaction “on the spot” and settlement typically within 48 hours

Outright Forward: The market in which agreement is reach at today’s price but delivery at some specified future date

Swaps: A market in which two transactions occur simultaneously; the purchase (or sale) of a pre-determined amount of currency on one date and a reverse of the transaction on some future date

Futures: Similar to the outright forward market, except that futures are traded through brokers on exchanges and executed with agreement terms describing the size of the transaction and delivery dates

Options: Like other types of options, the buyer has the right (but not the obligation) to buy or sell a currency at a defined strike price. Call options give the buyer the right to purchase a currency at some point in the future at a price agreed upon now.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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