Understanding How The Foreign Exchange Market Works

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The concept of exchanging one currency for another seems simple enough, but understanding who’s actually involved and what determines an exchange rate is a little more complicated. By the time you try to figure out why you’re being charged a given rate it can all seem quite mysterious.

This article aims to briefly outline how currency markets operate and to take some of the mystery out of the process. It explains why traditional methods of exchanging currency almost always leave the individual paying well over the odds for their travel money.

The FX Market

The global currency market, also known as the foreign exchange or simply ‘FX’ market, is the largest financial market in the world, with an average of $4 trillion exchanged daily by banks, financial institutions, corporations and individuals. That is about 12 times the total amount traded every day on the world’s stock markets. Looking at it another way, more than $45 million worth of different currencies change hands every second!

With so many participants and such a large volume of trading, the FX market moves at quite a pace, with rates changing constantly. But unlike other financial markets such as the stock market, currencies are not traded on a central exchange and for this reason there is no single and agreed price at any given moment. In the FX market there are a number of different rates, depending on who is trading, where they are based and how much they are buying or selling of a particular currency

The True Exchange Rate

Prices here are updated on a microsecond basis and the interbank rate is the closest you will get to the concept of a true exchange rate at any given time. To provide some transparency to the public, websites such as www.xe.com provide very close approximations of the rates trading in the interbank market.

In reality though, no one outside the inner circle of global banks can trade on these rates. As you move further down the food chain to smaller banks, financial institutions and corporates, the difference between the available rates and the true exchange rate starts to grow.

The biggest banks that control the FX market essentially operate a tiered system, offering the best rates to their biggest clients and progressively worse rates to smaller, less valuable clients. The business model is a simple one: currency can be bought or sold at the interbank rate and subsequently passed on to their customers at a rate that makes them a healthy profit. Their margin is simply the difference between the two rates. In a market where $4 trillion changes hands every day, it’s no wonder that the foreign exchange units of the world’s major banks are usually amongst their most profitable.

At the very bottom of the currency food chain is the individual who wants to get a relatively small amount of foreign currency for a trip abroad. In practice, this means that you as a customer will usually receive the worst rate in the market, sometimes up to 10% away from the interbank rate. The consequence of this is that you have less spending money with which to enjoy your holiday.

You may also notice that there is frequently a big difference between the ‘buy’ and ‘sell’ rates, so when you try to change your surplus foreign money back to your home currency you are likely to get a nasty surprise! Suddenly that 8% margin has become 16%!

Carrying large amounts of cash with you as you travel is risky and not all that convenient. You might try to avoid this by using your debit card or credit card whilst abroad, but you will usually end up, once again, with a very poor exchange rate. In addition you may well be charged a fee each time you spend money or withdraw cash.

WeSwap

For years, holiday makers and short-term travellers have been an easy target when it comes to exchanging currency. But the times, they are a-changing…

WeSwap is bringing the power of the people to the world of currency exchange with the concept of Social Currency. We allow people to swap directly with one another in a secure and efficient manner. Everyone swaps at the true exchange rate, which, you’ll now understand, represents a huge saving to you.

So come join us and jump straight to the top of the currency food chain!