Every country in the world is buying or selling to other countries in the world. How do they pay for it. As an importer, let us say in America, you would pay in Dollars. Similarly, if you are an exporter, you would want that buyer to pay in Dollars, and not in that country’s currency.
Therefore a demand is created for the dollar by your exports, and by your imports, that country has got dollars. Depending upon the volume of trade, that is exports and imports, either your country or that country has an excess or deficit in dollars. So if that country has an overall deficit in dollars, where does it go to find dollars to pay you? In the forex market.
That is as simple as that. Therefore, every country is trading currency of which they have an excess, and of currencies in which they have a deficit.
The players are the Governments, the Banks, the financial institutions, the investment bankers, authorised companies, and authorized brokers.
In determining what the rate is going to be for the exchange of currency, a number of econometric tools are used. A simple one is whether or not that particular country has a trade surplus or not. If it has a trade surplus, it means that it is holding a particular currency, normally the US dollar, in excess of its requirements. But keeping currency idle is not worth it. Money chases money.
Therefore, if America is deficit in its trade account, it has to find dollars in the forex market to pay off for its imports. Thus it contacts various countries which have surpluses or deficits (on products which America has a surplus), and the trade begins, based on demand and supply. Thus you find that one day a dollar is worth, say 1.50 in Sterling pound. The next day, the rate varies. Visit: http://www.forex-rebate-go.com/
For instance when the recent crisis regarding the sub-prime rate in house mortgages took place in America, the dollar took a steep plunge, forcing the Federal Reserve (the Central Bank for America) to intervene and cut interest rates. The dollar took a hit because the economy went in for a slide, due to lower results and lower employment. Thus the dollar when valued against the pound became lower, that is instead of 1.50 GBP (Sterling Pound), it became a dollar being traded at 2 sterling pounds.
The volume of trades in currencies is very high, and carries on day and night, without let or hindrance.
Nearly all major currencies are traded on the market, working on the principle of demand and supply. Every player in the market is always looking for opportunities to make a quick buck for the institution, and therefore they remain constantly online all the time.
The forex market is different from the stock market, because stock markets are local, and forex markets are global. Your stock market is, say, the NASDAQ. It is local. it does not matter that its indices are linked to markets elsewhere now. Basically, it remains a local buying and trading of stocks, listed on it.
On the other hand, forex markets involves all the countries which trade with each other, and is restricted to Governments, authorised dealers like large companies, investment bankers, investment funds, and individuals who have a licence to trade in the currency markets. You don’t require a licence to play the stock market, do you? That’s the significant difference.