The participants in forex trading and their role in the market
The importance of knowing who's who in the market
A huge part of
knowing the market is identifying who the market participants are and getting a
hold of the market structure. The forex market is the
most massive market by cash volume worldwide, with about $4 trillion worth of
currency changing hands daily.
Contrary to regulated stock markets that trade in shares of public companies, the forex market is not centralized, and it is best to see it as a series of fountains or a wedding cake - the most important participants at the top, with trades cascading down.
The largest
participants have the best terms and can move the market with their trades.
Because the market is so big, it is still hard for any entity to manipulate it.
The forex industry works in order of size from the top down.
Central Banks
The central banks are national banks. They are responsible for issuing and lending the national currency. Also, they are at the top of the 'wedding cake.'
Furthermore, central banks are the ones setting monetary policy like interest rates and increase or reduce the supply of their currency. Also, they have massive reserves of other currencies and stores of value like gold bullion. And this indicates that they hold several powers that can dramatically move the market in their currency when exercised.
For central banks,
it is way easier for them to devalue their currency than to maintain or
increase a value. Also, they have a role in lending and giving liquidity to the
largest banks that serve their nations. When these large banks face trouble,
the central bank must intervene to clean up any mess.
Banks
Most of the time, people trade market volume in the interbank market - between banks. Banks trade for themselves and their clients. Then, the 'big four' (Citibank at 12%, JP Morgan and HSBC at 8.8%, and Deutsche Bank at 7.9%) dominates the interbank market.
For themselves,
they trade as a speculative venture (but the size of this business is
decreasing) and establish their inventory of currency and be a dealer to huge,
professional market participants. As dealers, banks profit from the bid or ask
spreads they implement on exchange rates quoted to their clients.
Investment Managers and Hedge Funds
The most
significant customers of the banks are speculative hedge funds and managers of
other investment vehicles. They might want to exchange currencies for financing
purchases of securities denominated in currencies that they do not own, hedge
against risk in possible fluctuations in currency exchange rates, which could
severely affect their portfolios of securities, or to speculate upon such
fluctuations for profit. As hedge funds trade in an enormous volume and gain
much publicity, the pension fund industry accounts for a bigger total of assets
under management. But while their trading style tends to be more conservative,
hedge funds are more significant risk-takers that typically become an immense
influence upon the forex market.
Corporations
Similar to
investment managers and hedge funds, corporations deal with banks. More giant
corporations often deal with the larger banks directly. Then, smaller
businesses will work with smaller banks. Forex brokers are corporations and
belong in this niche in the chain of dealing. Plenty of corporations are
multinational or at least interested in international trade. And even if they
do not, their profits are open to the risk of fluctuations in currency exchange
rates.
Retail Traders
Unfortunately, this is the very bottom of the cake - trading on worse terms compared to any other listed above. Also, they need retail forex brokerages to trade. And these brokers might not be hedging their risk on their trades.
If they are, they will often use a bank for their forex dealing. In turn, it will use another bank, which might finally have behind it one of the 'big four' or tier 1 banks. For each level, the prices, spreads, and others will gradually worsen.
