Currencies float against each other to measure their worth in the global marketplace.
A currency’s value in the world marketplace reflects whether individuals and governments are interested in using it to make purchases or investments or holding it as a source of long-term security. If demand is high, its value increases in relation to the value of other currencies. If it’s low, the reverse occurs.
Some currencies are relatively stable, reflecting an underlying financial and political stability. Other currencies experience wild or rapid changes in value. That may be the sign of economic turmoil resulting from runaway inflation, deflation, defaults on loan agreements, balance-of-trade severe deficits, or policies that seem unlikely to resolve the problems.
Similarly, certain currencies are used widely in international trade while others are not. But, again, that results from the relative stability of the currencies and the volume of goods and services a country or economic union produces.
How does foreign currency trading works?
Most currency transactions are conducted online, though some occur over the telephone. Transactions are registered in electronic trading or dealing system.
Make a market
If a bank wants to buy a particular currency, a trader seeks a quote from a bank that is a market maker for that currency. That means the bank specializes in handling it.
Get a bid
The bank responds with the price that it would bid to buy and the price at which it would sell since it doesn’t know if the trader wants to buy or sell.
Agree to terms
If the trader wants the deal, he or she accepts. The bank that quoted a price confirms the details — what’s being bought or sold and the price — and the trader verifies the terms.
The trader who initiated the transaction enters the information in the dealing system and gets a confirmation.
The trade details are also entered into the bank’s in-house system and confirmed with the responding bank at the end of the day, either by phone or online.
Payment is sent electronically to a corresponding currency bank. So, for example, a New York bank would send payment in yen to its Tokyo branch or a designated Japanese bank if it didn’t have a branch there.
How are currency values set?
Between 1944 and 1971, major trading nations had a fixed, official rate of exchange tied to the U.S. dollar, which could be redeemed for gold at $35 an ounce. Since 1971, when the gold standard was abandoned, currencies have floated against each other, influenced by supply and demand and various governments’ efforts to manage their currency.
Some countries, for example, have sought stability by pegging, or linking, their currency to the value of a currency or basket of currencies. In Europe, the European Union established the euro as a common currency for participating member nations. Euro banknotes and coins are used internally and across national borders for all transactions.
Currency values of even the most stable economies change as traders are willing to pay more – or less – for dollars or pounds, or euros, or yen. So, for example, great demand for a nation’s products means excellent demand for the currency needed to pay for those products.
If there’s a significant demand for the stocks or bonds of a particular country, its currency is likely to rise in value as overseas investors buy it to make investments. Similarly, a low inflation rate can boost a currency’s value since investors believe that the value of long-term purchases in that country won’t erode over time.
Since currencies are traded in pairs, the value of one of the currencies in that pair depends on the value of the other. Therefore, establishing this relationship (price) for the global markets is the primary function of the foreign exchange market.
How to control the value of the currency?
Like other goods, currencies are bought and sold. These transactions mainly take place in foreign exchange markets. Currencies increase in value when many people want to buy them, and they decrease in value when fewer people want to buy them. And if there is a large amount of a currency in the market, its value will go down.
Governments generally try to keep their currencies stable, maintaining constant relative worth with the currencies of their major trading partners. One way to control the currency’s value is by adjusting the money supply, making more money available to stimulate the economy, or withdrawing money to keep inflation under control.
Another way to control currency values is by adjusting interest rates. When rates are high, international investors are more likely to buy fixed-income investments in that currency. Conversely, when rates are low, demand for those investments falls, often along with their exchange value.
Sometimes governments deliberately devalue their currency, bringing the exchange rate lower relative to other countries. One reason is that this makes the country’s exports relatively cheap, giving it a trade advantage.
Is there a market for foreign currency?
The foreign exchange market is a global online network where traders buy and sell currencies. It was created to facilitate the flow of money derived from international trade.
Foreign Exchange (forex or F.X.) is trading one currency for another. For example, one can swap the U.S. dollar for the euro. Foreign exchange transactions can occur in the foreign exchange market, also known as the forex market.
The Forex market is the largest and most liquid financial market globally. The Foreign exchange is a legitimate financial market with nearly US$5 trillion in turnovers daily. Moreover, it boosts imports and exports around the globe. Demand and supply determine the differences in exchange rates, which determine traders’ profits.
Currency markets consist of many different markets because trading between individual currencies constitutes a market.
Large-scale currency trading in the global foreign exchange market, or forex, is handled on telecommunications networks controlled by banks or other financial institutions.
In spot trading, the deal is settled or finalized within two days at current rates. Forward contracts involve setting an exchange rate that will apply when the currency is traded on a set date in the future. Finally, currency swaps involve exchanging one cash flow for another, such as a stream of income in one currency in exchange for a stream of income in another currency at a preset exchange rate.
Understanding Foreign Currency Trading And Value by Inna Rosputnia
Wishing you a great week!
Want Your Money To Grow?
Subscribe to get free research, trading lessons, and more insights.
(We do not share your data with anybody, and only use it for its intended purpose)