Aug 24 2009
Most of the companies and businesses need to import raw materials for production or export their finished products. Companies and businesses need to pay for goods and services that are denominated in other currencies. These companies and businesses deal through their banks instead of directly accessing the interbank market since they deal in smaller quantities of forex transactions. Learn
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In addition to paying for the goods and services, these companies and businesses also have hedging requirements. Large trade flows impact the forex markets as they tend to influence the supply and demand of currencies.
Sometimes these companies and businesses also take part in currency speculation in order to generate additional revenues. Cross border Mergers and Acquisitions (M&A) also tend to have a short term effect on the currency prices.
Currency conversions are involved in these M&A activities as these companies relate to different countries and involve sizable cash transactions. M&A between large multinationals usually involves huge amounts of money something like in billions.
As a forex trader you should be aware of any M&A deals that are likely to affect your trading. Major cross border M&A deals often involve change in the trading decisions of speculators as they anticipate a temporary shift in supply and demand of currencies involved.
Examples of some important central banks are the US Federal Reserve Bank (FED), the European Central Bank (ECB), the Bank of England (BOE) and the Bank of Japan (BOJ). Central banks play a very important role in the forex markets as they hold the key to the supply and demand of national currencies. FED is the most influential central bank due to the global reserve currency status of US Dollar.
Monetary policy involves the setting and adjustment of interest rates. Central banks are mostly concerned with the inflation, growth rate and unemployment rate in the national economies. For this they use the monetary policy.
Central banks normally don’t fix the exchange rate of their currencies. Sometimes, the central banks have to intervene directly in the forex markets especially if they are not satisfied with the currency exchange rates of their currencies. In this regard Bank of Japan (BOJ) is the most active central bank in intervening in the forex market.
Japan is an export oriented economy. A weaker Yen is always helpful in stimulating exports. Hence, if the BOJ thinks that Yen is getting stronger relative to US Dollar or Euro, it may sell Yen in the forex market to deliberately bring down its price relative to US Dollar or Euro.
This intervention by the BOJ may cause other institutional players to follow suit and further drive down the price of Yen to that desired by the BOJ. Central bankers also use verbal comments about the state of their national currency exchange rate also in order to achieve some results. So central banks have many tools at their disposal that they can use to achieve the desired currency exchange rate that they want.
Aug 24 2009
Most of the institutional investors speculate in the currency markets. They also often require foreign exchange to buy or sell foreign assets. Institutional investors and speculators like the hedge funds and the investment management companies tend to be very aggressive players in the spot forex market. Learn
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Most of these institutional speculators have international portfolios like stocks and bonds to diversify their holdings and to get a higher return. For example, an investment manager who is in charge of an international stock portfolio will need foreign currencies so as to pay for any purchase of foreign stocks.
Hedge funds are a different breed altogether. Hedge funds often practice a very different style of wealth generation from investment management companies. Mutual funds tend to be conservative in their investments. A major part of the mutual funds portfolio is diversified between stocks and bonds.
Hedge funds tend to adopt more aggressive forms of trading with the aim of generating a high return on investments. Hedge funds tend to be highly aggressive in their investment strategies.
Currency trading has now become a part of the investment portfolio of hedge fund managers. A portion of the investment portfolio of a hedge fund is specifically adopted for currency speculations with the objective of maximizing the overall portfolio returns.
You must have heard the name of George Soros Quantum Hedge Fund. George Soros made the profit by betting that the British Pound was too weak to stay in the European Exchange Rate Mechanism. He is famously known as the, “The man who broke the Bank of England.” In a matter of few days he was able to make a profit of $1 Billion with currency trading.
Last year hedge funds were highly active in the crude oil futures market. They drove the price of crude oil from around $60-70 to almost $150 within the span of a few months. Now hedge funds are actively engaged in the forex markets. Large hedge funds and the investment management companies are capable of moving the forex markets in their transactions.
Most of these hedge fund managers were involved in a number of different markets all over the world looking for making a quick killing. This shows how much powerful hedge funds became.
These hedge funds have the power to move the currency markets as well with their billions of dollars worth of daily buying and selling of foreign assets. All these foreign transactions require currency exchange.
However, the recent stock market crash has taken a heavy toll on a number of hedge funds. Some of them went bankrupt. Many may not survive and the hedge fund industry may undergo a major transformation in the near future as a result of the stock market crash of 2008.
Aug 22 2009
Retail forex market comprises of small individual traders most of whom trade in much smaller size compared to institutional investors. Retail forex traders can’t access the interbank market. They trade through their forex brokers.Know the
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This aspect of the over the counter nature of the retail forex market shifts the odds of success against individual traders especially if the forex broker acts as the market maker. The forex brokers usually take the opposite side of the transactions as the retail traders have to deal directly with their brokers.
Let’s take an example. Suppose you are the retail forex trader. You go long on EUR/USD by buying one standard lot as you are bullish on the pair EUR/USD. Effectively your forex broker will have to go short on EUR/USD by selling one standard lot to you. This is the only way to execute the transaction. Know these
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This arrangement does not sit well with most of the individual forex traders as they fear that the forex broker acting as the market maker will trade against them. This is not an uncommon practice among the forex brokers. There is an inherent conflict of interest between the retail forex trader and his/her forex broker.
Forex market and for that matter the retail forex market is an over the counter market with no central clearing house. There is a lack of standard data for traders. This makes it difficult for the individual traders or for that matter other players in the market to know the volume of trading for the different currency pairs.
It is not difficult to know the volume of stocks traded or the futures contracts traded, however, due to the decentralized nature of the retail forex market, this information cannot be provided. Stock and futures traders find it difficult to switch to forex trading due to this lack of volume data.
As there is no central exchange which records the currency transactions, there is no universal exchange rate of any currency pair at any given time. This is another feature of the retail forex market that you should be aware of is that currency exchange rates differ from place to place, screen to screen, depending on which party is offering what.
For example, the EUR/USD exchange rate on Broker XX screen may show 1.3500/1.3503, at the same time the EUR/USD exchange rate on Broker YY screen may be 1.3505/1.3508. Some individual traders are even not aware of this aspect of the retail forex market. So you may never know what the best price available is.
Spread on currency pairs may vary from broker to broker. Some forex brokers will set fixed spreads while the ECNs usually offer tighter but variable spreads for each currency pairs depending on the market liquidity.
Retail forex market is a 24/5 market. Being a 24 hour market, boundaries of the trading day are blurred. Traders from Hong Kong will show a different timing from their US counterpart who tend to display the EST. For this reason, many traders tend to use the GMT.
Aug 20 2009
The spot forex market is a decentralized network of buyers and sellers. There is no physical central exchange that acts as a central clearing house. The spot forex market is an over the counter market.
Over the counter means that the buyers and sellers make a binding contract with each other after agreeing on the price and this is not carried through an exchange unlike the forex futures trading that is carried out through the exchange like CBOT, CME etc.
Forex traders in the spot forex market carry out their activities by dialing directly with one another or through brokers on telephone or internet. There are several advantages of a central exchange like the counterparty risk for the trades is reduced. There is trading anonymity something that big players want to hide their trails.
In 2007, Chicago Mercantile Exchange (CME) along with Reuters launched FXMarketSpace; the world’s first centrally cleared global forex market place. In this centrally cleared system, CME will act as the clearing house and guarantee the performance of all the contracts for both buyers and sellers.
Unfortunately FXMarketSpace is an institutional trading platform and is not open to retail forex traders. Only sophisticated investors with net worth of more than $20 Million can trade on the FXMarketSpace.
The spot forex market is still skewed against the retail forex trader. Recently NFA (National Futures Association) had also passed certain new rules that make it more skewed against the small investor like you and me. Why is it so?
With the advent of the internet, it became possible to introduce trading platforms for the retail investors. Previously spot forex trading was the playfield of the big banks, multinationals and the hedge funds.
Retail spot forex is seeing a lot of growth in the recent years. A mushroom growth of online forex brokers took place. Many did not have even enough capital with them to start the brokerage business. Most of these forex brokers behave like bucket shops. But this is the way; the spot forex market has developed over the years.
Why these players trade forex? What type of advantages they have over the retail forex traders? It is essential for you that you understand the nature of the spot forex market and who are the main players.
Over the counter (OTC) means that the spot forex market is spread all over the globe with no central location! Over the counter nature (OTC) of the spot forex market means that currency transactions do not take place at any single place. Discover a revolutionary new
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A player’s access to the spot forex market depends on the quantity of transactions of large amounts of money. Players in the spot forex market range from those who trade billions of dollars daily to those who only trade just a few thousand dollars daily. Now who are the main players in the forex market against whom you as a retail forex trader will be competing?
Aug 20 2009
The world’s big banks are the main players in the spot forex market. These big banks make an exclusive club where most trading activities take place. This club is known as the Interbank Market. Discover a revolutionary new
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Down the hierarchy in the spot forex market are the smaller banks, big multinational companies, hedge funds and other institutional investors or speculators and the retail forex brokers. The wealthier you are and the more money you have or are able to get credit for, the more chances you have of accessing this big boys club.
These players conduct currency transactions in the interbank market if they have large capital and have credit standing with the large banks. The independent retail traders lie at the bottom of the market structure.
The retail forex traders trade through their forex brokers. They generally trade in much smaller lot sizes. Central banks are also occasionally involved in currency transactions. So there is no central exchange in the spot forex market to set the prices. Then who sets the currency prices?
Market makers make the bid and ask prices based on the currency movements that they anticipate will take place. Without a central exchange, the currency prices are set by the market makers.
Many banks have professional traders solely dedicated to trading forex for speculation. Largest banks are the major market makers and they handle billions of dollars worth of forex transactions on behalf of their clients like the other institutions and companies and also for themselves.
This big money laden network is knows as the interbank market. Interbank market is where large banks deal with one another. The resulting massive flow of money handled by these big banks is what primarily drives the currency markets.
The transactions carried out by these big banks like the Citigroup, Barclays, UBS, Deutsche Bank, Bank of America, Merrill Lynch etc amounts to the greatest bulk of the total daily forex volume. Most of the trading activity takes place in the interbank market.
How do the big banks deal with one another in the interbank market? The banks deal directly with one another through the electronic brokering platforms like the Electronic Brokering Services (EBS) or Reuters Dealing 3000 Matching. These brokering services get the best available rates for the various currency pairs.
These brokering systems match buying and selling requests from the bank dealers. Between these two competitors they connect at least 1000 banks together. The banks establish specific credit lines with one another in order to deal with one another in the forex market as there is no exchange to serve as each bank’s counterparty.
Smaller banks that also trade forex also get access to these brokering platforms. Next large companies come. As the main market makers, these big banks constantly quote bid and offer prices to one another thereby making the market.
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