Forex Market Structure
To make this as simple as possible, we can draw an example from a market that most people are familiar with which is a stock market such as the New York Stock Exchange. This is how the structure of the stock market looks like. Buyers and seller have no choice but to make their trades on one centralized exchange which controls the pricing of its listed stocks.
An image of the Forex market structure.
However, in Forex, you do not need to go through a centralized exchange like the New York Stock Exchange which has only one price for buyers and sellers at any given time. In the Forex market there is no single price for a given currency at any time which means that quotes from different currency dealers will vary in price. This makes the Forex market a decentralized market as shown by the graphic below.
An image of the Forex market structure.
This might seem a bit overwhelming at first but it is what makes the Forex market unique. The market is so large and the competition between dealers is so active that the retail investor typically gets fair pricing most of the time. This is because clients have many options for how they transact with brokers these days.
Even though the Forex market is decentralized, this does not mean that there is no hierarchy to how it operates. The participants in the Forex market can be organized into a ladder and is illustrated below.
An image of the Forex market structure.
At the top of the Forex Market ladder are the major banks of the world with a few smaller but still decent sized banks thrown into the mix. It is the major banks that comprise what is known as the Interbank Market. The participants in the Interbank Market trade directly with each other through Electronic Brokering Services (EBS) or the Reuters Dealing 3000-Spot Matching system. The competition between the EBS and Reuters is quite intense and each is constantly trying to out-do the other for market share.
The medium and small sized banks tap into this Interbank liquidity trying to grab the best pricing for their clients. Their clients are the retail market makers, retail ECNs and hedge funds. Since these smaller retail institutions do not have tight credit relationships with the players in the Interbank Market they are forced to buy liquidity from the medium and smaller sized banks that have the established credit relationships within the Interbank Market. This means that the rates are slightly higher than those found in the Interbank Market.
At the very bottom of the ladder are the retail traders. It used to be difficult for retail traders to tap into the Forex Market for the purpose of speculative trading. However, given the huge technological advances in computer hardware and the internet, everyone in the world now has easy access to the Forex market. This has levelled out the playing field and given the small guy a chance at staking his/her claim in the Forex Market.
Related Wikis
Readers of Forex Market Structure also viewed: