NoaFX Tutorial

1.4 Influence of market forces

There are various forces or roles being played by various entities that drive the currency flows in the Forex market. In this topic, let us take a look at the various players who drive the market and what their limitations and responsibilities are.

Unlike the stock market, the currency flows through the forex market are "regulated" or made possible by various players. They are;

  • Banks
  • Commercial companies
  • Central Banks
  • Hedge Funds
  • Investment/Investment management firms
  • Retail Forex brokers
  • Companies that transact Forex but are not banking services based
  • Remittance/Funds transfer companies

Let us take a detailed look at the role these various entities play;

  • Banks

Large commercial banks and security dealers perform at this level of the inter-bank market. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and are also not known to players outside the inner circle. This is very much a controlled environment.

A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account. According to a report done in 2014, volume done at this level accounts for 58% of all transactions. After that there are usually smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX-metal market makers.

  • Commercial companies

The financial activities of companies seeking foreign exchange to pay for goods or services play an important part of this market. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. At times, mergers and acquisitions of companies at an international level worth billions of dollars can cause a significant impact at the market.

Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

  • Central Banks

Central banks are financial institutions that control monetary policies/supply at a national level. By using reserves to stabilize or control currency flows, they can have a single handed deciding stake in the exchange rate of the nation's currency. At times, even suggestions of a central bank's intervention in the country's fiscal policies can cause widespread rumour and speculation which is enough to cause the effects as if they had indeed implemented such a policy.

Such is the influence of the Central bank's acts on a national level and its effects can be clearly felt in the market with its local currency being affected in the Forex market.

  • Hedge Funds

Majority of Forex transactions are speculative. Notably, a very large portion of these transactions are controlled by fund management firms and of which sizeable portion is dominated by hedge funds. Hedge funds primarily have many positions and are constantly transacting currencies to gain profits with a speculative perspective.

Much of these funds are aggressive and are notably of syndicate dynamism, which can have a large unprecedented market effect. Though they are similar in their objectives for managing funds such as investment management companies, their nature of trading and positions management is different.

  • Investment/Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative currency operations which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the number of this type of firms is quite small, many have a large value of assets under management, and hence can generate large trades.

  • Retail foreign exchange brokers

Retail traders (individuals) constitute a growing segment of this market, both in size and importance. Currently, they participate indirectly through brokers or banks.

There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the price obtained in the market. Dealers or market makers, by contrast, typically act as a principal in the transaction versus the retail customer, and quote a price they are willing to deal at. The customer has the choice to decide whether or not to trade at that price.

In assessing the suitability of the FX trading services, the customer should consider the ramifications of whether the service provider is acting as a principal or an agent. When the service provider acts as agent, the customer is generally assured of a known cost above the best inter-dealer FX rate. When the service provider acts as principal, no commission is paid, but the price offered may not be the best available in the market. Since the service provider is taking the other side of the transaction, a conflict of interest may occur.

  • Companies that transact Forex but are not banking services based

Many companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but currency exchange with payments i.e., there is usually a physical delivery of currency to a bank account.

  • Remittance/Funds transfer companies

Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $98 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange Financial Service Ltd.


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