CFDs on currencies
The foreign exchange market is organised in a decentralised manner and is - although it enjoys far less attention in media reporting than, for example, the German stock market - by far the largest market in the world.
The Bank for International Settlements (BIS) estimates the daily (!) trading volume at several thousand billion US dollars.
Exchange rates are quoted as the exchange ratio of one currency against another. If, for example, the euro/US dollar is quoted at 1.30, 1.00 € will pay 1.30 $ on the market. This corresponds to the most common quantity quotation in Europe.
Of course, the exchange rate can also be given in reverse form, which is called the price quotation. Then €1.00 costs $0.77 (rounded).
The customs of the foreign exchange market
The majority of FX brokers on the German market do not actually allow private clients to trade physical currencies, but use the legal and technical shell of contracts for difference. FX trading is therefore usually CFD trading anyway. Nevertheless, the special features of the currency market are maintained.
Thus, currency pairs are quoted with four decimal places - the only exception is the Japanese yen with two decimal places.
The change in the rate by one unit to the fourth decimal place is called a pip in the jargon. The trading range of a day, but also the performance of trading strategies, is very often measured in pips.
Currencies are traded in lots on the foreign exchange market. A standard lot is equal to 100,000 units of the base currency, which is the currency quoted on the left in volume quotation.
Most CFD brokers adjust their contract sizes to this. Many brokers also allow trading in minilots (10,000 units of the base currency) and micro-lots (1000 units).
No exchange trading
There is no regulated exchange trading for foreign exchange. The EUREX futures exchange has been offering futures on currency pairs for some time. So far, however, this has had almost no influence on the offer of CFD brokers, even though the offer is explicitly addressed to market makers.
A fundamental problem is therefore the evaluation of the prices that a broker provides. In this way, the problem corresponds to that with (other) CFDs.
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The official reference rates of central banks are not suitable as a benchmark for active trading, since the rates are only fixed once a day. However, three different market models are distinguished for exclusive trading in currencies.
In addition to market makers, there are STP brokers who forward customer orders to a liquidity pool, to which mainly banks are affiliated. There are also ECN brokers who connect their customers to a virtual trading network to which institutional investors are also connected in addition to other private traders. ECN forex trading is considered the best possible solution, but usually requires very high minimum deposits.
Central banks are the most important players in the FX market
Central banks such as the European Central Bank (ECB), the Federal Reserve Bank in the USA or the Bank of Japan play a particularly important role in the FX market. Exchange rates react particularly sensitively to suspected or actual changes in monetary policy. Therefore, the regular central bank meetings are among the most important events in FX trading.
If a central bank unexpectedly lowers the key interest rate for its currency area or if the key interest rate reduction is greater than expected by the market, this usually leads to a devaluation of the affected currency.