The Uniqueness of FX Trading

In the FX market you are not really buying or selling anything even if on the face of it appears that you are buying one currency and selling another. It is basically a speculative market and there is no transfer of ownership of any currency in any case. Trades are simply accounting entries and profit or loss is netted or calculated on the basis of market price. A trader’s account is credited or debited in the currency in which it has been denominated. For example, even if the exchange rate of EUR/USD is quoted in US dollars, an Australian dollar denominated FX account will be credited in AUD.

The existence of FX market is basically for the purpose of facilitating exchange of currencies for exporters, importers and other trade related international transactions including payroll and mergers and acquisitions. However, trade related needs for foreign currencies amounts to only about 20-25 percent of the daily turnover in the FX market. Such transactions are in the domain of large banks that buy or sell foreign currencies on behalf of their clients. The rest is all speculative trades initiated by multinational banks, large financial institutions, hedge funds and even high net worth individuals. In fact, the FX market opened for the small individual investor only recently, thanks to the Internet.

In essence, when a trader initiates a trade, he is actually buying one currency and selling another because currencies are traded in pairs. If a trader buys a standard lot (equivalent to a hundred thousand units) of AUD/USD, he is essentially exchanging USD for AUD. It is almost similar to exchanging cash for, say, a laptop except that no transfer of ownership is involved in FX trading. However, the transactions may only be accounting entries the effects are as real as any other trading activity.