Forex Market Participants

To understand the forex market, you need to understand the following market participants and their motivations:

  • Banks
  • Reserve banks
  • Hedge funds
  • Individual traders
  • Brokers

Banks

Banks comprise a large portion of the total turnover. They use the foreign exchange market to buy and sell currencies that are needed for foreign exchange for their customers, to hedge or protect against market movements on behalf of their customers (for example when an importer may wish to protect against adverse currency movements) as well as for trading purposes.

Reserve banks

These are government owned organisations that are responsible for managing the economy of their countries by setting interest rates and they also may take positions on foreign exchange in an attempt to regulate or smooth exchange rates. Examples include the Bank of England, the Bank of Japan, the Federal Reserve and the Reserve Bank of Australia.

For example, the Bank of Japan may enter the market to sell Japanese Yen and buy Euros if they believe that Japanese Yen are priced too high relative to Euros.

Reserve banks are typically active in their own currency. They may make enormous trades that can quickly result in significant short term market movements. Usually the actions of reserve banks can be seen when there are sudden spikes or dips in a currency.

In addition, reserve banks often manage the release of key economic statistics. This information is eagerly awaited by market participants and results in immediate price movements if the statistics differs from the consensus view.

Hedge funds

Hedge funds are professional investment firms that usually manage funds on behalf of high net worth investors. They may invest in a variety of financial instruments, including foreign currencies. Their motivation is speculative profit for their investors, as they earn their money from a percentage of profits earned.

Individual traders

Individual traders are increasingly active in the FX markets. This is driven by the ready access to the market through the Internet and the opportunities available to earn significant profits with a relatively low capital investment.

Individual traders are often unsuccessful. In fact, about 90% of individual traders lose money during their time in the FX markets. Individual traders often don’t have systems, and don’t manage risk well.

In addition, individual traders face higher transaction costs than professional traders as they don’t have direct access to the market and have to use a broker. Also, individual traders can’t watch the market all the time as they usually have other committments such as work or family life.

These factors are a disadvantage, but the advantage is that the individual trader can choose whether to participate in the market at any given point in time. Professional traders are pretty much obliged to trade all the time by the nature of their jobs which means that they may not be able to be as selective about the trades that they enter.

Brokers

What a Forex Broker does? Brokers provide access to the FX market to individual traders. Typically banks and hedge funds have direct access to the market as they are a part of the market.

A broker will provide account keeping services, execute trades and usually provides some software to place orders and allow you to look at current prices and charts.

Brokers earn their profit by charging a spread. This is a difference between the buying and selling price. For example to buy EUR/USD, the price may be quoted 15/19, which means that the broker makes a spread of 4 basis points per trade. A trade is either buying or selling a foreign currency position.

Forex Market Overview

This first part of this lesson gives introduction to the forex market, and the mechanics of trading. The next part of this lesson explains about the different types of market participants and their motivations. You need to know this to understand some of the factors that influence the market.

Introduction to Forex Trading

The foreign exchange (or FX) market is the largest financial market in the world, with daily turnover of over $1 trillion.

The FX market is an unofficial decentralised market so there is no central exchange as there is for common stocks or futures. Prices are set by agreement between buyers and sellers. This means that FX prices may vary between different points at a particular time – there is no official quoted price. In practice, if prices get out of alignment, traders called arbitrageurs quickly step in to profit from any short term discrepancies, and this means that prices tend to be about the same regardless of geographical location.

About Currency Trading

The major currencies traded in the FX markets are the Euro, US dollar, Japanese yen, Swiss franc, Canadian dollar, Australian dollar and New Zealand dollar. Other currencies are available, but are not traded often and this means that the cost of trading them is much higher, so FX traders generally focus on the most popular currencies.

FX transactions are always between two currencies, which are called currency pairs. For example, a common pair is EUR/USD. When someone buys this, it means that they are buying Euros and selling US dollars.

Prices are moved by differences in supply and demand within an FX market. If there is a high demand to buy a currency, but a low supply of the currency (holders unwilling to sell), then prices will move up. If more holders wish to sell a currency than buyers wish to purchase, then prices move down. Supply and demand are influenced by the expectations of forex traders – that is, their view of where the currency price will move to in the future.

Forex contract sizes

The usual contract size for ordinary FX traders is USD $100,000. This is one lot, which is the minimum size normally traded. You put up a margin, usually $1000-$2000 depending on your broker.

Some FX brokers now offer mini-contracts. These are 1/10 the size of regular FX contracts, and represent $10,000. The margin is proportionately smaller. The cost of trading mini-contracts is higher, as there is more work for the broker to do in fitting the mini-contracts into the market. However mini-contracts are a great opportunity to start trading without having to risk a lot of money, and can help new traders become familiar with the market before moving on to the full size contracts.

Forex Trading Indicators

Many Currency traders use indicators like relative strength index (RSI), moving averages, stochastics as part as FX trading system.

Why Trade Forex?

Forex Trading Advantages

One of the benefits of forex trading is that the small investor has opportunities that may not be available in other markets, or other forms of investment.

High Yield Forex Trading

FX trading is one of the few businesses where a trader can realise a large fortune starting with a small initial investment. This is because FX trading is highly leveraged, so a small margin can control a large position.

FX markets can show significant price movements, so there is a potential for large profits and losses.

This leverage and price volatility gives you an opportunity to make a high return on your money, or conversely make significant losses. Other pages on this site help you to develop a strategy to maximise profits and to close out losses quickly while they are still manageable.

Reality of online forex trading

The Reality of forex trading is obtaining the fortune mentioned above requires a lot of hard work and it is far from easy, but it can certainly by done by most people who have a passion for trading and are prepared to work hard.

Forex Liquidity

The global FX market is very liquid due to its huge size and turnover. This means that you can easily enter or exit trading positions at the current market price whenever the market is open. The actions of a trader are unlikely to cause any significant impact on such a huge market and there will always be a buyer or seller at the market price.

In an illiquid market, such as low turnover shares, taking or exiting a position may move change market prices. In addition, a counterparty (another buyer or seller) may not be available to allow you to transact.

Openess and transparency

The FX market is also transparent. This means that any information that affects the market prices is available to all market participants. Small FX traders have access to the same information that large institututional traders use. This can again be contrasted with the stock market, where insiders may have access to price sensitive information such as unreleased sales figures not available to other stockholders.

The sheer size of the FX market (turnover of over $1 trillion per day) also means that it can’t be manipulated easily. Whilst large institutional traders or governments can cause small short term price movements, the market is too large and has too many participants for medium or long term prices to be manipulated.

Opportunity to trade long term trends

The FX markets often show long term trends. This means that when trading the forex market, the trader can take positions in the market over longer periods of time and take advantage of large long term movements which can represent significant profits. This is because currency prices movements reflect long term economic conditions. Prices move in trends as traders come to a consensus and buy or sell currencies over a period of months as prices move from one equilibrium point to another. This is certainly a big advantage of currency trading.

Forex Swing Trading

FX Trading offers the opportunity for swing trading. This is where positions are held overnight but generally not for the long term.

FX Day Trading

Trading can also be intraday. FX Intraday trading is where positions are opened and closed on the same day and are not held overnight.

Minor capital requirements

One of the great principles of forex trading is the fact that a trader can open an account with less than $1,000. Since your position is leveraged (that is you transact on margin), you can trade a position of up to $100,000 for every $1,000 of your own money. Some brokers also offer mini-contracts which have a margin of only $100 which allows you to trade a position of $10,000.

This is usually a lot less than the amount required for other investments. We recommend that you invest more than the minimum required as this will allow you to absorb any initial losses.

FX Trading Online

FX trading online is automated, and you can easily trade through the Internet 24 hours a day while the market is open. There is no need for retail premises, or to employ staff.

When you want a break, you can simply close your positions and stop trading. Compare this with owning a normal business where you need to arrange for someone to cover you if you want to go away on holiday.

There is no paperwork as this is also automated. You can view your positions and account balance on-line. You generally pay no direct fees as the broker uses the difference between the buy and sell price as his profit. Typically on a single $100,000 trade, the cost is around $50 to buy and $50 to sell.

You can easily start trading part time without having to leave your current job or business. Most trading platforms give you the ability to place stop positions to protect your profit, or close out a loss making position before the market moves against you.

Forex Trading Demo

It’s very easy to get a forex trading demo account with a broker allowing you to practice as long as you want before opening a live forex account.

24 hour Currency Trading

One of the benefits of currency trading is that the market is very liquid 24 hours a day. No other financial market even comes close to this.

Forex Trading at Home

One big advantage of forex trading is the opportunity to work at home and spend more time with your family. All you need is a good internet connection and a windows PC.

Forex Regulation

Many people who open their own business spend a lot of time and money in complying with a range of government regulations, filling in returns and keeping up to date with various laws. You may have to pay for licenses and collect sales tax. This is accepted as part of running a business, but reduces the time available for you to make money for yourself.

In comparison, FX trading is the essence of free market capitalism.

Nepotism and ability to play organisational politics counts for nothing in the FX markets. There is no-one holding you back and you will succeed or fail based on your ability to develop and implement a trading strategy.