1.9 Forex Market Structure and the Market Players

Who all trade in the Forex market and how it is structured.
 
The structure of the Forex market is rather unique because it is a massive Over-the-Counter (OTC) market and is independent of any centralized exchange as in the case of stock markets.
 
The participants in this market are:
 
  • Central Banks
  • Major commercial banks
  • Investment banks
  • Corporations for international business transactions
  • Hedge funds
  • Pension and mutual funds
  • Insurance companies
  • Forex brokers
  • Speculators
 
The Forex market is made up of various kinds of transactions, and as per the BIS (Bank for International Settlements)Triennial Survey in 2010 the broad break-up is as per this chart.
 
Average daily turnover of Forex trading.
 
As you can see, the spot market, the area of our interest, is about a third of the total action.
Since there is no centralized exchange, for a display of the real interbank market, technology is provided by two major platforms known as the Electronic Brokering Services and the Reuters Dealing 3000 respectively. These are not centralized exchanges; instead they are only a means for providing centralized pricing information.
 
The Forex market structure may be diagrammatically represented like this:
 
Forex market structure.
 
The top guns are the major banks and some smaller or medium-sized banks which make up the interbank market, the two tiers at the apex of the pyramid. 
 
The largest banks, such as the Royal Bank of Scotland, Deutsche Bank, BNP Paribas, Barclays Bank, HSBC, UBS, and Citigroup, among others, really determine the FX rates through their operations. They are the ultimate frontier for global FX transactions and have the true overall picture of the changing demand and supply scenario of any currency. Through the size of their operations they effectively lay down the bid-ask spread that trickles down to the lower tiers.
 
Banks are able to view rates and deal if required, using the two platforms EBS and Reuters we mentioned above. Choosing one platform or the other would depend on the currency pair to be traded. Traditionally, the pair-wise choice of platform would be as follows:
 
EBS and Reuters trading platforms.
 
The next tier is made up of the non-bank entities such as retail market-makers, brokers, ECNs, hedge funds, pension and mutual funds, corporations etc.  They access the FX market through banks, also known as liquidity providers. They pay higher spreads for executing the transactions. Of this class, the corporations are a very significant player, because they are constantly buying or selling FX for their cross-border purchases or sales of raw materials or finished products. Their activities in the Mergers and Acquisitions arena also create significant demand or supply of currencies.
 
Sometimes, governments and central banks also intervene in the FX markets if they see a need to re-align market rates. For example, if the U.S. monetary authorities elect to intervene in the Forex market, the intervention is conducted by the Federal Reserve Bank of New York. When a decision is made to support the dollars' price against another currency, the foreign exchange trading desk of the New York Fed buys dollars and sells the foreign currency; conversely, to reduce the value of the dollar, it sells dollars and buys the foreign currency.
 
The speculators and retail traders make up the last tier, and they pay the largest spreads, because their trades effectively get executed through two layers. The sole intentions of these players are to make money trading the fluctuations in the currency prices. With the advent of the internet and technology that lets the small guy participate in this huge market, it is now possible for anyone to trade Forex. What’s more, he doesn’t need a huge sum to start off, but more of that in later chapters!
 
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