What drives this enormous market? Let's explore some of the main reasons why investors and businesses engage in foreign exchange transactions. The first one is more intuitive and something many have done, to some extent, buying foreign currency to make payments. This is particularly common in international trade. For example, a business might need to purchase a foreign currency to pay an invoice received from a supplier overseas.

Closely linked to this is risk management, another key driver of FX transactions. In global trade, there is often a time delay between ordering goods and making the final payment. While this delay might seem beneficial, as paying later is generally preferable, it introduces foreign currency risk. Take for instance, a European importer who agrees to buy commodities priced in US Dollars with payments due in two months while the price in Dollars is fixed. The importer cannot know the exact cost in Euros, their home currency until the exchange rate at the time of payment is determined. FX markets offer several products to manage or even eliminate this risk. Making risk management a significant driver of FX trading.

The same FX products that can be used for hedging can also be used for speculation. By taking a position in the FX market, investors can potentially capitalize on their own views of future movements in exchange rates. For example, a macro hedge fund might aim to profit from the expected appreciation of one currency relative to another, and they enter into a trade today to buy that currency.

Finally, FX transactions are also driven by diversification efforts. Global investors frequently spread their investments across multiple countries, which naturally involves exposure to different currencies. By trading FX, these investors manage their currency exposures and diversify their portfolios to reduce risk and optimize returns.