Forex Participants and Players
The world of Forex has an immense number of participants, ranging from Chinese housewives to the most powerful central bankers. The objective of each type of participant differs and the actions each take may have dramatic effects on the market. It’s important to remember that the Forex market is an off exchange marketplace which means there is no central exchange where all orders are cleared, as in the case of well-known exchanges such as the New York Stock Exchange or the Chicago Mercantile Exchange.
The bulk of trading is done between trading partners on the interbank. However, small retail traders are unable to trade directly with partners on the interbank. Therefore, some participants in the Forex market exist to create a marketplace for others to trade. Currency dealers create a market for smaller retail speculators and offset their risk by trading with their larger partners on the interbank. There is a definite food chain among Forex market participants, with interbank members on top and retail speculators on the bottom.
The Flow of Forex Market Participants
An image of the flow of Forex market participants.
The Interbank Market
The word Interbank is a loose term held over from the early days when banks traded for clients and themselves over the telephone. Today trading is conducted electronically, with quotes from buyers and sellers matched up on the interbank market automatically. Many interbank members act as market makers for the currency pairs traded on the spot currency market and offer the quotes that ultimately drive the pricing you see in your trading software. Currently, the largest market makers on the interbank are banking giants such as Citigroup, UBS, Goldman Sachs, and Deutsche Bank. Lehman Brothers was a major interbank market maker prior to its demise in September 2008.
An image of big bank logos.
Participants on the interbank market are big-dollar players, since the lowest accepted trade size is set at an even $1 million. Many banking participants on the interbank market fill orders for customers who actually intend to take delivery of the currency being traded. However, most interbank members also trade the bank’s money as speculators attempting to make a profit just like any other currency trader.
The advantage interbank market makers have over a regular retail trader is access to order flow information. If you are the market maker and you see all the orders, you have insider information about the direction of the prices. Taking a trade against that information provides a significant source of revenue for many financial institutions.
Interbank members trade only with partners with which they have arranged credit line agreements. This is an important point to understand because it affects the pricing you receive from your currency dealer. The quotes flowing from interbank trading partners ultimately drive the pricing you see through your currency dealer’s trading software. The more trading partners a dealer has, the more quotes at which they can execute a trade, resulting in more competitive pricing for the retail trader.
Institutional Traders
Institutional traders represent corporations, investment firms or hedge funds trading directly on the interbank market or through currency dealers. Hedge funds may participate as speculators while corporations participate to protect their interests against currency exchange risk for their out of country operations.
Corporations conducting business globally face a potential issue of fast-moving exchange rates, devaluing their profits made overseas. These corporations may participate in the currency market by hedging their risk directly in the currency market rather than waiting for a bank to exchange the currency for them.
Most institutional traders representing corporations are involved in some kind of hedge to protect the value of their goods or services from exchange-related risks. Institutional traders may include professional money managers looking to diversify and hedge against the risk of loss in the equities market.
Central Banks
Central banks play an important role in guiding the forces of supply and demand for a country’s currency on the Forex market. Their monetary policy statements, interest rate decisions, and ability to intervene in the Forex market should make every trader pay close attention to their actions.
Central banks are also tasked with controlling the money supply of a nation’s currency, which directly affects supply and demand. Low supply and high demand tend to increase the value of a nation’s currency, whereas high supply and low demand will devalue it. Balancing growth with inflation is the typical goal of central bank policies.
Central banks may also change their overnight lending rates as a tool against inflationary pressures. The interest rate set by a central bank can influence the value of a currency based on yield. The higher the central bank rate, the higher becomes the yield for holding that currency, influencing demand positively.
Currency, Central Banks and Websites
| Currency | Central Bank | Website |
|---|---|---|
| United States Dollar | The Federal Reserve Bank | www.federalreserve.gov |
| Great Britain Pound | The Bank of England | www.bankofengland.co.uk |
| Euro | The European Central Bank | www.ecb.int |
| Canadian Dollar | The Bank of Canada | www.bank-banque-canada.ca |
| Australian Dollar | The Reserve Bank of Australia | www.rba.gov.au |
| Japanese Yen | The Bank of Japan | www.boj.or.jp or www.boj.or.jp/en |
| New Zealand Dollar | The Reserve Bank of New Zealand | www.rbnz.govt.nz |
| Swiss Frank | Swiss National Bank | www.snb.ch/en |
Retail Currency Dealers
The average retail trader doesn’t have the credit or capital required to participate directly with interbank trading partners. Retail currency dealers act as market makers for small-volume currency traders. Currency dealers manage their risk by balancing their portfolios of retail orders among the customers for which they are making a market. When they are overexposed to market risk due to an imbalance of short or long orders, they offset their risk by taking positions with their trading partners on the interbank.
It is important to understand that currency dealers do not operate the same way stockbrokers do. The spot currency market does not have an exchange and therefore the currency dealer often fills a customer’s order by itself assuming the risk. This is commonly known as taking the other side of the trade. In other words, the currency dealer is betting against your ability to make money. If you lose, the dealer wins and collects the spread for doing the transaction. This process is referred to as B-Booking in amongst currency dealers. This is significantly different from a stockbroker, who is paid a commission for brokering your order to the exchange, where it is matched with an anonymous third-party order on the exchange. There is an inherent conflict of interest when your dealer is profiting by taking the other side of your trade.
Traders have historically complained about poor order execution, excessive quoting, or stops being “gunned,” and there is was some basis for these complaints. Nowadays, this is far less frequent and with the information available on the internet, many retail traders have become aware of which companies operate in a less than honest way. However, Forex is largely an unregulated market, and shady dealers do exist. Currency dealers are aware of these perceptions and are now marketing no dealing desk execution or direct interbank trading as an alternative order execution strategy to taking the other side of the trade. These trading platforms suggest the dealer is not involved with your trade, and passes the order directly to a trading partner.
Retail Speculators
Retail speculators may be trading their own account or client funds through a managed account program. Some speculators at the retail level may be trading for clients looking to hedge portfolio risks. However, most are looking to generate profit. Retail speculators are too small to trade directly on the interbank market and clear their trades through one of the many retail dealers available to make a small-volume market for them. For the most part, retail speculators represent people like you and me, trading small-volume accounts purely for the sake of making a profit. The number of retail speculators involved in Forex worldwide is massive and continues to grow as the popularity of currency trading grows.
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