Let’s face it – most of us only think about Forex (FX) when we go on holiday. Or the gutsier ones among us may dabble in some FX trading. Beyond that it seems more like an abstract concept than anything else. However, here are 3 fun facts about FX that you probably didn’t know about.
#1: Deliverable or not?
If you trade FX, you may have wondered why your choices are usually limited to the major pairs (EUR, JPY, AUD etc.), and not currencies like MYR, CNY, TWD and so on.
The reason is that those currencies are not freely deliverable by nature of their government’s strict exchange rate control policies, i.e. Prices not allowed to be determined by demand and supply. This is usually done to prevent exchange rate volatility and/or to achieve certain goals (i.e. The RMB being kept artificially low was the reason why everything was made in China).
On a real world basis, this typically results in a two-tiered FX market, onshore and offshore. There will be an interbank market that is strictly regulated within the country itself (onshore), and another one trading in non-deliverable contracts (NDFs). These contracts are usually not available to retail investors, and are used as hedging tools by MNCs or speculation tools by funds and other institutions.
#2: Affects All Other Markets
Most investors will think of stocks, bonds, property, FX, and so on as separate asset classes. However this cannot be further from the truth.
Among financial markets, FX markets are the messiest in terms of capital inflows and outflows. There is typically a confluence of many different interests in the market at any one point in time. These interests can range from, but are not limited to, the following: Mutual/Pension Funds, Hedge Funds, Smaller Speculators, Trading Algorithms, Central Banks, Bank Trading Desks, MNCs, and so on. For example, huge inflows into US stocks from Japanese pension funds would need to go through the USD/JPY pair.
There are also asset correlations between certain currency pairs and other assets, which traders can capitalize on. Traditionally USD/JPY and commodity currencies are strongly correlated to risk sentiment, thus impacting stocks and bonds. More recently, USD/CAD has been trading closely with crude oil prices.
Long story short – when there are big moves in currency markets, there will be ramifications somewhere else.
#3: The Importance of USD
Say you are going to Japan on a holiday, and you go to the money changer to convert your SGD into JPY. Technically speaking you are changing your money into USD first. Why is that so?
Being the world’s reserve currency means that all currencies are primarily quoted against USD. Thus, the exchange rate you get for changing SGD into JPY actually requires a conversion into USD first, then into JPY.
In FX terms, you are buying USD/SGD and selling USD/JPY – meaning you are taking the bid/offer quote for two pairs, not one. Hence anything not quoted against USD tends to have wider buy and sell prices. How wide the buy/sell spread is tends to also depend on trading interest, seen in geographically linked currencies like SGD/MYR or JPY/KRW, for example. Therefore, where you change your money also affects whether you receive a competitive quote or a bad quote.
Read Also: How to Protect Yourself When Trading Forex
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