What the FX does it all mean?
We know that business owners are busy running their businesses. They’re not meant to be foreign exchange experts. FX, when done right, can save you £££’s on your bottom line. But for many small exporters, the fear of losing their money, combined with the constant jargon, means sticking with the bank is often seen as the safest and easiest option.
So, welcome to the first instalment of our FX guide, including a jargon buster. We hope it will be useful to new exporters trying to find their way around the international payments market.
But seasoned owners and FD’s, please read on as well. We’ll try to give you some useful tips for understanding exactly how international payments work as well as refining your foreign exchange strategy to benefit your business. And we’ll try to make it interesting.
Here goes, with a quick introduction to how it all works. We’ll start with the wholesale market.
The foreign exchange (or FX or forex) market is the largest traded market in the world, with around £5 trillion changing hands per day. About 60% of that takes place in London, more than anywhere else in the world.
Much of this trade, over 92%, takes place on the “interbank” forex market. The interbank market is used for the buying, selling, exchanging, and “speculation” of currencies by FX trading professionals.
Speculation in the forex market is notoriously difficult and risky because of the random and sometimes extreme nature of price movements. George Soros and his $1 billion profit in 1992 was a rare example of a strategy that worked but many more don’t. It’s certainly not something that business owners should be doing with company funds – but more about that later.
These professional players are banks, central banks, investment management firms, hedge funds, retail forex dealers, and investors in the forex market.
To be fair, with investment terms like swing trading, naked call, after hours, blind entries, 30-day wash rule, straddle, triangles, descending tops, ascending bottoms, pump and dump, partial surrender, stop order, position limit, voluntary liquidation, and explicit interest, some may have been lured in under false pretences. (None of these terms are included in the glossary below because they are nothing to do with international payments – if your minds are so dirty you can look them up yourselves!)
The banks all have their own “market makers”. These market makers quote prices at which they are prepared to buy or sell particular currency “pairs” to their counterparts in the interbank market. This is known as an exchange rate.
When they quote a price, they quote a “bid” and an “offer”. One is the exchange rate they are prepared to buy at, and the other is the rate they will sell at. The difference is the “spread”.
Once they have quoted the exchange rate, market makers are committed to buying or selling those currencies at that price. They may put size or time limits on the price. If the counterparty (say another bank) decides to deal on that price, the market maker will take the currency exposure onto their own book.
Then, they can make a profit in one of two ways:
- If there is lots of activity going on in that particular currency pair, they may simply continue to buy the currency on their “bid” and sell on their “offer”. Each time they complete a round they make the “spread” as their profit.
- They may hold the position until the market moves up or down in their favour, and then sell to another market maker with a higher bid
Market makers look at a number of criteria when making their prices. These include:
- The rates being quoted by other market makers
- Their own exposure – what positions they already have on their book
- Their view on the future direction of the currency pair
- Available liquidity – how much of that currency is available in the marketplace
The rest of the FX market is made up of currency conversion for international trade settlements and investments.
The FX / Forex / Foreign Exchange Jargon buster
FX, forex or foreign exchange market
– the global marketplace for the exchange of currencies.
– the practice of betting that a particular currency will strengthen or weaken against another currency, often within a given timeframe.
– a financial institution which sets FX prices in the wholesale interbank market
– the buying and selling of currencies in large volumes between financial institutions such as banks and hedge funds.
– the price that a market maker or dealer will pay to buy a particular currency
Offer or Ask
– the price that a market maker or dealer will sell a particular currency for
Over the counter
– a decentralised electronic marketplace in multiple locations where participants agree deals between themselves
– the price of one currency relative to another currency
– two currencies whose values are quoted against each other to make an exchange rate
If your business imports or exports then you need to understand foreign exchange and how to ensure you get the right FX deal for your business – find yourself a solution that focuses on fairness and transparency of trades to give yourself the best chances.
Yorkshire Powerhouse – giving an FX about YOUR business!
Have you any questions?
Here at Yorkshire Powerhouse, we’re happy to help as much as possible – is there anything else we can do to help you, do you have any further questions or can we help introduce you to an expert – please let us know:
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