Our regular Investor Glossary series seeks to give you the low down on the most common, frequently confusing words and phrases in the finance industry.
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This week we look at various aspects of currency trading, a vast 24 hour market with a terminology all of its own.
The make up of a decentralized market allows its investors to deal directly with one another, rather than coming to a central exchange to trade. Facilitated by technology, networks of investors can gather information, compare prices, and agree direct deals worldwide, around the clock. As such, foreign exchange markets are a prime example of this form of market structure.
Simply, this is an abbreviation of foreign exchange, the decentralized market place on which currencies are traded. Also referred to as FX or currency market, many types of buyer and seller operate within the market, from individuals to global companies and countries. The currency markets operate 24 hours a day through the working week, breaking for weekends (based on Greenwich Mean Time cut offs). The currency conversion afforded by these markets is an important factor in the facilitation of international trade.
Floating Exchange Rate
A floating currency rate is one that calculates value by supply of, and demand for, the currency. This is as opposed to fixed rates, which are set between countries by tying a currency to the value of another (or a selection of others). Under a floating rate system, central financial institutions like the U.S. Federal Reserve can still involve themselves in the buying and selling of their currency in order to avoid dangerous fluctuations in value. This tends to be a last resort, however.
Carry trading refers to investors selling currencies with low interest rates and utilizing the funds brought in to buy an alternative, higher yielding currency. The strategy relies on the contrasting rates holding true, otherwise the investor may be left with a negative position if the low-high currency rates reverse before all transactions are completed. Exchange rates can fluctuate significantly, making this a strategy not without risk, but the gains can also be substantial if the difference in currency rates are wide.
Is anything still a bit unclear? We're listening and watching for your comments!