1.3 The Forex Market Size and Liquidity

 
Picture representing FX market size and liquidity.
 
The Bank of International Settlements conducts a survey every three years of the Forex market, and one of the important metrics that is available in the survey is the breakdown of the FX market by currency traded. 
 
 
The figures of the BIS as per its last four reports are shown below graphically, with the 2010 percentages labeled above the bar for each currency. As is clear, the dollar has the lion’s share of the transactions at 85% or above. The Euro and the Yen bring up a distant second and third place at 39% and 19% respectively. (You might wonder how the percentages add up to 200%! – because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%).
 
 
Graph of currency distribution in forex market. 
 
The dollar’s all-pervasive influence on the FX market is very clear from the above chart.
 
 
The reasons for this are not far to seek:
  • The US dollar is the preferred payment option in many major global transactions – for example in the oil industry all payments are made in U.S. dollars, hence the different players need to first exchange their home currencies into dollars and then pay for the oil.

 

  • The US dollar is the currency of the U.S.A, which is the world’s largest economy with a very stable political system.

 

  • The U.S.A is also a military superpower on the one hand, and on the other, is home to the most liquid and biggest financial systems in the planet.

 

  • The world keeps its reserves in U.S. dollars. As per the latest available data as at June 2011, almost 60% of the world’s official FX reserves were kept in US dollars. See the chart below:
 
Curreny composition in world forex reserves - a comparison
 
 
Given that the dollar is numero uno in the pecking order of FX currencies, as a budding trader, you would need to keep your eyes wide open to any development affecting the dollar.
 
The dollar is the king of worldwide Forex reserves.
 
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