Forex Flows - Understanding The Flow Of Foreign Exchange

Welcome Fellow Traders to the third installation of this series of hubs. Today, I would like to take this opportunity to help you understand what is know as Forex Flows which essentially create the foreign exchange market so that traders like you and I can make money. I know many of you are itching to start trading Forex but please take my professional advice and STOP. I believe that you have to take the time to understand the mechanics and the basics of the forex market before we get to the good stuff. This hub will be your resource to answer questions such as

• What are Forex Flows?
• How is the Foreign Exchange Market Driven?
• What is The BIS?
• What drives Forex Flows?
• What are Spot Transactions?
• What are Outright Forwards?
• What are Currency Swaps?
• What are OTC Interest Rate Derivatives?
• What is the most traded currency?

In this Hub we will take a peak inside foreign exchange flows. We will have a closer look at some of the primary financial instruments that move from one institution to another and how these moves are and transactions are facilitated. These moves and transactions between major financial institutions are referred to as Forex Flows and this is what essentially creates the forex market so that you and I, the retail trader can capitalise on the opportunities that present themselves when major Forex Flows take place.

“Every trade is a portrait of the trader who managed it.” When you make a trade, the way in which you managed that trade is a direct reflection of where you currently stand as a trader. The net result of the trade that you managed is a direct reflection of your skills and abilities as a trader. In order to succeed, you have to take this seriously and think about it as a business.

The Bank For International Settlements serves as a bank for central banks. This international organisation serves to foster financial and monetary cooperation between institutions. Essentially, the BIS are the only real accounting that analyses Forex Flows. As this serves as the mother of all central banks, all accounts must be disclosed to the BIS on a triennial basis in order to evaluate Forex Flows.

The Bank For International Settlements measures Forex Flows by evaluating turnover in Forex markets. The main instruments that have to be measured are

1) Spot Transactions

2) Outright Forwards

3) Currency Swaps

4) OTC Interest Rate Derivatives

Spot Transactions

A Spot Transaction is defined as a foreign exchange transaction where each party promises to pay a specific rate to the other on the same day or within one to two days. To give you a practical example, say you have downloaded Forex trading software and you give it instructions to buy the Euro. You will find that this will not be settled until after two days. So essentially what the broker does is perform what is know as a rollover. What this means is that you don’t have to take delivery on the currencies i.e. you will not have Euros deposited directly into your account. If you are trading with a bank, you may require a guarantee from the bank before using this instrument.

Outright Forwards

An Outright Forward is defined as a future commitment whose terms have been established now. This is a contract in which one side has agreed to buy or sell at a set, agreed price at a future date. To give you an example, if you are an International Businessman based in the UK and your main activities occur in the United States, you are in a very risky position and exposed to fluctuations on the US Dollar. This scenario is also an accounting nightmare because you will not be able to budget as currencies fluctuate daily. You can hedge against this by buying out an Outright Forward Contract.

Currency Swap

A Currency Swap involves the exchange of an interest-bearing instrument in one currency for the same in another. The price of an interest-bearing instrument is influenced by the yield on both currencies and the spot rate at the time.

OTC (Over The Counter) Interest Rate Derivatives

The Over The Counter Market is made up of commercial and investment banks. Essentially what these institutions do is create interest-bearing products such as loans etc to trade with one another and thus contributing to Forex Flows.

• The average turnover in the Forex Market stands at over 2 Trillion US Dollars
• This is over a 60% increase since 2001 due to the effects of globalisation, establishment of huge international businesses and massive movement of funds internally between these corporations.
• 33% of the Forex Market is comprised of Spot Transactions (explained above). Outright Forwards and Currency Swaps contribute to about 50% of the Foreign Exchange Market (also explained above). This is why you need to have an understanding of these instruments because they play such a massive role in the Foreign Exchange Market and you will need to know these when you start trading in Forex and start analysing news feeds.
• Less than 10% is actually delivered.
• The US Dollar is the most traded currency either as a base or cross and is present in about 89% of trades in the foreign exchange market. This I am sure will give you the sheer volume of US Dollars that are being traded daily (89% of 2 Trillion anyone?)

Fun Facts About Currencies

• As mentioned above, the US Dollar is the most traded currency.
• The EUR / USD makes up 32% of the market and is the most traded currency pair in the foreign exchange market. USD / JPY comes in second with 13%. GBP / USD makes up 13%. AUD / USD makes 6% and USD / CHF is present in 4% of the Forex Market.
• The Aussie Dollar and the Canadian Dollar are known as commodity currencies, which mean that the price of these currencies is influenced by commodity prices.
• The Swiss Franc is a gold-based currency and its price is a reflection of prices of Gold.

Thank you for taking the time to read this Hub. I hope this has enabled you to better understand the Forex Market. Stay tuned for many more articles that will come your way.

All Success

Afthab

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