There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the
over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies
instruments are traded. This implies that there is not a
single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. A joint venture of the Chicago Mercantile Exchange and
Reuters, called
Fxmarketspaceopened in 2007 and aspired but failed to the role of a central market
clearing mechanism.
[citation needed]The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.
Fluctuations in
exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and
trade deficits or surpluses, large cross-border
M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers'
order flow.
Currencies are traded against one another. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the
ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the
base currency that is quoted relative to the second currency (YYY), called the
counter currency (or quote currency). For instance, the quotation
EURUSD (EUR/USD) 1.5465 is the price of the
euro expressed in
US dollars, meaning 1 euro = 1.5465 dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (
e.g. USDJPY, USDCAD, USDCHF). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (
e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).
The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency
correlation between XXXYYY and XXXZZZ.
On the
spot market, according to the 2010 Triennial Survey, the most heavily traded bilateral currency pairs were:
- EURUSD: 28%
- USDJPY: 14%
- GBPUSD (also called cable): 9%
and the US currency was involved in 84.9% of transactions, followed by the euro (39.1%), the yen (19.0%), and sterling (12.9%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.
Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency
ZZZ would have usually involved two trades:
EURUSD and USDZZZ. The exception to this is
EURJPY, which is an established traded currency pair in the interbank spot market. As the dollar's value has eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has increased dramatically. Transactions in the currencies of commodity-producing countries, such as
AUD, NZD, CAD, have also increased.
