May 3, 2021 | by sandeep
Getting to Know the Forex Market’s Major Participants
It’s very important to know who the other traders are and what they do in the Forex market. This will give you a better understanding of where you as a retail trader fit into this entire operation.
At the top of the financial hierarchy, we have the US Federal Reserve (The Fed), the Bank of England (BOE), the European Central Bank (ECB), and other central banks around the world.
Central Banks provide banking services to both a country’s government and major banks operating within their borders. These institutions manage interest rates and the overall banking system in a country.
Governments use the Forex market to make international trade payments or change the amount of foreign currencies they hold in their reserves.
Hence, as currency traders, you should pay particular attention to central banks. Their announcements, speeches, meeting minutes and other events, which indicate the government’s monetary policies, are freely available online, can be downloaded and should be read by all aspiring professional traders.
The top tier of this financial hierarchy is also shared with some of the world’s largest banks such as Barclays, JP Morgan, UBS, Citigroup and Deutsche Bank. These form what is called the Interbank System.
These banks exchange currencies amongst themselves, making it where the most volume is traded in the Forex market.
At this level, there’s no centralized exchange like in the stock market. These transactions between major banks are known as over-the-counter (OTC) because they are not made via a centralized exchange. If you have bought shares of Apple, you know that the company’s stocks are traded in a centralized exchange called NASDAQ.
At this interbank level, you find banks trading huge amounts of currencies to each other with very tight spreads. They probably use something like an electronic broker service (EBS) or a competing service such as the Reuters Dealing 3000 Spot Matching system. Not all banks receive the same rates, but some of the more creditworthy banks, like the ones mentioned above, get a slightly better deal than others.
Below the top tier, we find Large Corporations.
Many of these companies need to purchase goods and services from other countries when they’re doing business. Therefore, what they do is they pay for goods and services in their local currency. To complete the transaction, these companies need to exchange their local money into the currency used in those countries with whom they are doing business.
Take Apple as an example. They sell tons of iPhones throughout the world, receiving revenues in different countries and currencies. If they wanted to convert that back or repatriate that money, they would have to use the Forex market to exchange those profits.
However, they’re not going to get the very best prices because they’re not a major bank. So they’re not going to be trading at the interbank rate. Instead, what they’ll do is they’ll trade through a major bank, an arrangement that gets them a slightly worse rate.
Traders, Forex Companies and the Electronic Communication Network (ECN)
Further below the hierarchy, we’ve got Brokers who use electronic communications networks (ECN), which is simply a computer system that facilitates trading by allowing participants to access quotes from other banks. Currency traders can get access to these slightly better prices via an ECN account but they need to pay a small commission for this service.
Brokers and forex companies are not major banks. Therefore, they are not part of the interbanking system. They don’t get the very best prices and they have to do their transactions via major banks. As a result, they will give just a slightly worse rate compared to that used between major banks.
All the way down in this hierarchy are the Retail Traders.
In the past, it was not easy to gain access to the Forex market, other than getting awful rates at the tourist office or when changing money to go on holidays.
Now, however, we can access the Forex market via electronic trade platforms. Lots of retail broker offerings were not accessible to retail traders until the late 1990s. Before that, we would need to fork out a couple of hundreds, if not millions of dollars, just to get started trading.
Thankfully, the Internet has brought about many online changes, one of which is access to brokers who have brought Forex to our homes and computer screens. Obviously, you do not get the same rates as a major bank but it’s a fiercely competitive market out there. Surprisingly enough, however, the rates that retail traders trade receive with their little trading accounts are not that far away from what a major bank gets when they’re trading $50 or even $100 million at a time.
Let’s look more closely at Investment Banks and what they do as part of the Forex world.
Firstly, retail banking is where we have a bank account, a savings account, maybe a loan or a mortgage, and where our salaries get paid.
On the other hand, an investment bank like JP Morgan or Goldman Sachs gets involved in matters like mergers and acquisitions. This is where a company looks to buy another company and the investment bank advises them on how to do it, how much to pay, how to finance the project, and how to be compliant with the regulator in the country where they are operating. In turn, the investment banks take a cut of the deal.
Investment banks also raise capital for a company looking to build a new factory or expand in some way. The investment bank will advise on how to raise this money and, if needed, issue shares or bonds. Investment banks handle everything, sourcing money, finding investors, maybe even suggesting a pension fund. They provide advice on the price and even arrange for the deal’s underwriting.
If a company needs to raise capital to buy goods, and if the shares or bonds issued have not been taken up in time for the company to pay for the goods, then the investment bank can compromise to buy anything that hasn’t been sold in time. Again, the bank will charge you a percentage of the money that’s raised.
Private placements are another service offered by investment banks. This is a kind of fast track investment instrument with far less regulatory requirements to go through when dealing with institutions.
Investment banks can also design structured products, selling to either pension funds or life insurance companies. A structure is where the investment bank packages lots of things together like stocks, bonds, currencies, etc., and sells it. This product generally offers one of two scenarios: the worst-case scenario is this package will deliver money back after two years, whereas the best-case scenario can make the investor four or five percent. So, in theory, it’s quite a safe asset.
A small part of an investment bank’s business is proprietary or prop trading. This is where a trader makes decisions on trades using the bank’s money, exactly like what you do as a retail trader. Prop trading is only a small fraction of the investment banks activity.
The vast majority of the time, investment banks are market making, which means they’re offering a price to buy and sell an asset. The market maker is a broker or dealer who’s willing to buy or sell an asset while facilitating the trading of that asset.
For example, the currency exchange firm at the airport is a market maker. They’re making a market for us to change dollars to Euros or whatever it is. As a market maker, the currency exchange firm is not only setting up the buy price but also setting the selling price for the customers who wish to buy from them.
In its market maker capacity, investment banks offer attractive price points to hedge funds and pension funds for large quantities of money. As a result, prices offered are far better than what you would expect to get from the currency exchange firm at the airport. And these investment banks are not only doing this in the currency market but also with stocks and bonds, commodities, oil and gold, among other instruments.
A Hedge Fund collects money from investors and financial institutions and trades with it.
They speculate based on certain rules that they have set in their risk strategy, very much like what a retail trader does. One day, if you choose to work for a hedge fund, you’ll find that your skills will be hugely required and rewarded at a higher rate than perhaps in an investment bank. Of course, you need to practice what you’ve learned and achieve a three-year track record of success to be able to work for a hedge fund.
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*Any opinions, news, research, analyses, prices or other information contained here are provided as general market commentary and do not constitute investment advice. FXPRIMUS does not accept liability for any loss or damage, including without limitation to, any loss of proﬁt, which may arise directly or indirectly from the use of or reliance on such information.