What is currency exchange?

What is currency exchange?

Currencies can be exchanged for other currencies, and there are more reasons to do this than most people realize.

People are familiar with the currency exchange in the context of tourists stopping by a currency exchange kiosk so that they can buy trinkets at the local tourist traps, but the Foreign Exchange (Forex) market, where currencies are traded, is the largest market in the world by far.

Currencies are exchanged for each other on a massive scale on the international Forex market. Thousands of banks connect through electronic trading systems which are part of the interbank forex market. Millions of smaller-scale traders and individuals also engage in Forex trading, either over-the-counter or on regulated international exchanges.

Investors can trade currencies at the current spot price or use forward contracts and derivatives. Some ETFs now offer exposure to various baskets of foreign currencies. Institutions and individuals engage in these trades as hedges against fluctuating exchange rates and as speculative instruments to capitalize on possible changes in the future.

Most of the time that investors talk about currency exchange they refer to it as Forex, FX, or simply Foreign Exchange. Banks, businesses, and investment institutions hold positions and reserves in foreign currency to provide the liquidity they need at a known exchange rate (the one they already traded at).

Most currency traders make money on spreads, fees, or commissions, and sometimes on arbitrage.