FOREIGN EXCHANGE / THE FINANCIAL TIMES LEX ( VERY HIGHLY RECOMMENDED READING )

Foreign exchange

Published: December 14 2010 15:12
Last updated: December 14 2010 19:45

Foreign exchange is not an asset class. There is no underlying store of value in currencies. Rather, trades are a series of zero-sum games; every winner has an equal loser. So why is the forex market now the world’s biggest? Billions are wholly inadequate to capture the phenomenon. The latest triennial survey for the Bank of International Settlements, covering a period that began at the onset of the credit crisis, finds daily volumes of $3.98 trillion. Assuming 250 trading days a year, annual volumes are a sliver short of $1 quadrillion.


By 2007, volumes had quadrupled since George Soros’s 1992 coup against sterling. But in spite of the epic crash of the yen carry trade, total volumes still rose 20 per cent in the past three years. At the margin this growth has come from high-frequency traders, smaller banks, and a growing band of retail traders. Almost half of it (48 per cent) came in the UK.


Evidently, many people think it is bright to leverage up to place bets on currencies. But why? The old argument that forex is uncorrelated with stocks and bonds is discredited. Traders may believe that in spite of appearances, forex is not a zero-sum game because many players, like tourists and importers, are not playing that game to win. Ergo, some who are playing that game to win can indeed win. But now that 45 per cent of trading volume comes from algorithmic traders alone, that argument looks decidedly weak.


All the churn creates value somewhere – principally in London, where $1,584bn changes hands in the forex market every day.

That is about 140 times the average daily volume on the London Stock Exchange. Such frantic trading runs the risk of seriously distorting the terms of international trade, while new entrants risk discovering that forex is, indeed, a zero-sum game.

Copyright The Financial Times Limited 2010.