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The foreign exchange market operates as a decentralised global marketplace where exchange rates for currencies worldwide are traded. This over-the-counter (OTC) market facilitates various activities, including currency buying, selling, exchanging, and speculating on the relative values of different currency pairs.
India’s foreign exchange market turnover
The Forex market is a diverse range of entities such as banks, forex dealers, commercial enterprises, central banks, investment management firms, hedge funds, retail forex dealers, and individual investors. These stakeholders collectively contribute to the dynamic and multifaceted nature of the foreign exchange market.
Participants in the foreign exchange market
- Commercial banks: These institutions play a significant role in facilitating currency exchange services for businesses, individuals, and other financial entities.
- Corporations: Companies engaged in international trade and commerce rely on forex transactions to facilitate the import and export of goods and services.
- Government: Government institutions participate in forex markets to manage foreign reserves. It also assists in stabilising their country’s economy.
- Centralised banks: Central banks engage in forex activities to exert control over monetary policies, interest rates, and the regulation of currency supply.
- Individual traders: Individual traders and speculators participate in the market with the aim of making money from changes in currency prices.
- Hedgers: Entities such as exporters and importers utilise forex markets as a means of hedging against adverse currency movements that could impact their financial positions.
- Brokerage firms: Acting as intermediaries, brokerage firms facilitate transactions on behalf of clients and provide them with access to the forex market.
- International organisations: Certain international entities may partake in forex markets to implement policies and provide financial assistance as required.
Types of foreign exchange market
- Spot markets: The spot market is known for its immediate transactions, ensuring swift delivery of various currency pairs. This minimises exposure to market uncertainties that can affect prices.
- Futures market: In this market, two parties enter into a legal agreement to buy and sell currency pairs at a predetermined price and future date. These transactions are formal and offer protection through predefined conditions.
- Forwards market: Similar to the futures market, the forward market involves negotiation between parties regarding contract terms. Forward contracts are more flexible as they are traded on the over-the-counter market.
- Options market: The advantage of currency options is that they grant investors the right (but not the obligation) to sell currency contracts at a future date. Premiums are paid by buyers to sellers for the option to cancel the contract at any time.
Functions of the foreign exchange market
- Transfer function: The main role of the foreign exchange market is to enable the exchange of foreign currencies or financial resources across international borders.
- Credit function: Forex also acts as a creditor to facilitate the flow of goods and services across borders. It provides short-term loans to importers for financing foreign purchases.
Advantages of foreign exchange markets in India
- Flexibility – Forex operates 24/7, eliminating concerns about time zones and allowing traders in India to engage in currency trading whenever they wish.
- Full transparency – Unlike some markets susceptible to malpractices like insider trading, the decentralised nature of the foreign exchange market spanning multiple continents and time zones ensures a high level of transparency.
- Wide range of trading options – The forex market offers an extensive range of trading options, encompassing currencies from virtually every country. Traders can choose between spot trading and future agreements based on their preferences and risk tolerance.
- Low transaction costs – Transaction costs in the forex market are low. Commissions are either minimal or absent, particularly for retail traders. Revenue for forex dealers primarily comes from the “spread,” the difference between the quoted buying price and the bid, which is typically very low.
- Market volatility – While high volatility is often viewed negatively in financial markets, it can be advantageous in the forex market. Currency fluctuations are influenced by factors such as political developments, economic stability, investor confidence, and government policies, most of which evolve gradually, allowing informed investors to make well-informed decisions.
- Leverage – The forex market stands out by offering investors the opportunity to employ substantial leverage, which can significantly magnify their profit potential. This comes with high risk hence it is important to use caution when using leverage.
- Demo accounts – Many forex market dealers offer demo accounts, enabling traders to practise without risking any capital. These accounts replicate live trading conditions, providing invaluable experience and building trader confidence.
The foreign exchange market in India presents a world of opportunities. Its global reach, flexibility, transparency, low transaction costs, and access to demo accounts make it an attractive choice for those interested in trading foreign currencies. As you gain familiarity with the market’s intricacies and select the right currency pairs, you can confidently participate in the dynamic world of forex trading in India.
Forex market is one of the pillars of the global economy as it helps in cross-border transactions. Without currency conversion, imports and exports between two countries would not be possible.
A currency pair represents two currencies, where one is exchanged for another.
USD/INR is a currency pair, suggesting the units of INR required to buy one unit of USD. The first currency of the pair is usually the major currency.
India’s forex market allows trading in 7 currency pairs:
USD/INR, EUR/INR, JPY/INR, GBP/INR, EUR/USD, GBP/USD, and USD/JPY
Yes, forex trading is legal in India. The market is, however, highly regulated by the Reserve Bank of India and the Securities and Exchange Board of India. Hence, traders must be mindful of their transactions and ensure to tie up with brokers registered under SEBI.
The forex market is highly liquid and volatile. Hence, profits and losses are equally probable. There are also other risks such as broker scams, counterparty defaults and more.
Hence, traders must be cautious of their trades and use hedging strategies like futures, swaps and options to mitigate the risk of price fluctuations.