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National central banks
play an important role in the forex Exch. market. |
They try to control the
money supply, inflation, and/or interest rates and often
have official or unofficial target rates for their
currencies. They can use their often substantial foreign
exchange reserves, to stabilize the market. Milton Friedman
argued that the best stabilization strategy would be for
central banks to buy when the exchange rate is too low, and
to sell when the rate is too high - that is, to trade for a
profit. Nevertheless, central banks do not go bankrupt if
they make large losses, like other traders would, and there
is no convincing evidence that they do make a profit
trading.The mere expectation or rumor of central bank
intervention might be enough to stabilize a currency, but
aggressive intervention might be used several times each
year in countries with a dirty float currency regime.
Central banks do not always achieve their objectives,
however. The combined resources of the market can easily
overwhelm any central bank.
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The main trading centers are in London, New
York, and Tokyo, but banks throughout the world participate. As
the Asian trading session ends, the European session begins,
then the US session, and then the Asian begin in their turns.
Traders can react to news when it breaks, rather than waiting
for the market to open.
In April 2004 the average daily international foreign exchange
trading volume was $1.9 trillion, according to the BIS study
(Triennial Central Bank Survey of Foreign Exchange and
Derivatives Market Activity 2004 - Final Results). |
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Trading characteristics
Due to the over-the-counter (OTC) nature of currency markets, there is
no single unified foreign exchange market, there are rather a number of
interconnected marketplaces, where different currency instruments are
traded. This implies that there is no such thing as a single dollar rate
- but rather a number of different rates (prices), depending on what
bank or market maker is trading. However, in practice the rates are
often very close, otherwise they could be exploited by arbitrageurs.
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Most Traded
Due On the spot market, according to the BIS study, the most
heavily traded products were: EUR/USD (28%), USD/JPY (17%), and
GBP/USD (14%).
The US currency was involved 89% of transactions, followed by the Euro
(37%), the Yen (20%) and Sterling (17%).
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Although trading in the euro
has grown considerably since the currency's creation in January 1999,
the foreign exchange market is thus still largely dollar-centered.
No Insiders
There is little or no 'inside information' in the foreign exchange
markets. Exchange rate fluctuations are usually caused by actual
monetary flows as well as by expectations of changes in monetary flows
caused by changes in GDP growth, inflation, interest rates, budget and
trade deficits or surpluses, and other macroeconomic conditions. Major
news is released publicly, often on scheduled dates, so many people have
access to the same news at the same time.
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