The Foreign Exchange Market

Foreign exchange,’ ‘Forex’ or ‘FX’ is the home of the inter-bank and wholesale market for exchanging one currency for another and thrives in what is an enormous sea of money. It trades across the globe in over 100 currency pairs in the largest of the world’s financial markets!
Institutional FX
Basically, Institutional Forex is the big end of town when it comes to foreign exchange. Here, we are talking about a market with daily transactions in excess of 3 trillion dollars. To be ‘big’ in this business is to talk about huge amounts of funds being traded in an instant. While it is standard to trade in 5 to10 million dollar parcels, quite often 100 to 500 million dollar parcels get quoted. But what is important (and comforting) to note, is that even financial institutions are vulnerable to market moves and they are also subject to market volatility. In a practical sense, what this means is that because the market is simply too big, no one player can hope to control this largest of the world’s financial markets.
No one is bigger than the market – not even the major global brand name banks can lay claim to being able to swing the markets. Thus, so-called ‘insider’ information is not only very hard to come by, it is quite doubtful that even if someone had it would it be anything but a ‘blip on the screen’ with minimal value.
The Participants
Banks
Whether big or small scale, banks participate in the currency markets from the point of view of managing their own foreign exchange risks and that of their clients. They also speculate in the currency markets should their dealer/traders have a particularly strong view of the market. What probably distinguishes them from the other players is their unique access to the buying and selling interests of their clients. This knowledge can provide them with insight to the likely buying and selling pressures on the exchange rates on a particular day or other small timeframe.
Deals are transacted by telephone with brokers (we will talk about these people later) or via an electronic dealing terminal connection to their counter party. The usual transaction time is somewhere between 5 and 10 seconds. The skills of the foreign exchange dealer demands agility of reflexes and decisiveness, particularly when we are talking about transaction sizes of multi-million dollar amounts.
The ostensible role of the foreign exchange dealing desk in a bank or other financial company is to make profits trading currency directly and in the managing of in-house and clients’ trading positions. However, their roles will also include periodic hedging or arbitrage opportunities.
Brokers
The foreign exchange broker acts as an agent in the same way that a stockbroker acts in the equities market. The slight difference being that they usually confine their activities to acting between interbank market participants and they do not accept orders from corporate clients.
Through their extensive and direct electronic contacts with the banks, brokers take and match currency buying and selling orders of their bank clients. Of course, this is done for a fee. The value to the banks using this service is that it is usually done quickly because orders can be placed and dealt in a matter of seconds, and it avoids the bank having to deal on a competitor’s price and pay the ‘spread’ on the transaction.
Many of these brokering functions have been significantly computerized, cutting out the need for human handling of the orders.
Central Banks
The majority of developed market economies have a central bank. The role of a central bank tends to be diverse and can differ from country to country. In Singapore for instance, it is the Monetary Policy of Singapore (or MAS for short) and is charged with the responsibility of maintaining an orderly market for the national currency, which is known as the Singapore dollar.
In a practical sense this involves monitoring and checking the prices dealt in the inter-bank market. Sometimes, they even ‘test’ market price by actually dealing to check the integrity of the quoted prices. In extreme circumstances where the central bank feels prices are out of alignment with broad fundamental economic values, the central bank may ‘intervene’ in the market to influence its level directly. The intervention can take the form of direct buying to push prices higher or selling to push prices down. Another tactic that is adopted is stepping into the market and ‘jawboning,’ or commenting in the media about its ‘preferred’ level for the currency.
Bankers, fund managers and companies all tend to respect the opinions of the central banks (if not always agreeing) as their sheer financial power to borrow or print money gives it a huge say in the value of a currency. The opinions and comments of a central bank should never be ignored and it is always good practice to follow their comments, whether it in the media or on their website.
Corporations
As the name implies, this represents companies and businesses of any size from a small importer/exporter to a multi-billion dollar cash flow enterprise that are compelled by the nature of their business to engage in commercial or capital transactions that require them to either purchase or sell foreign currency.
Fund Managers
These participants in the currency markets are basically international and domestic money managers. They tend to deal in the hundreds of millions, as their pools of investment funds tend to be very large. Because of their investment charters and obligations to their investors, they are constantly seeking the best investment opportunities for those funds.
In short, they invest money across a range of countries and class of investments on behalf of a range of clients including pension funds, individual investors, governments and even central banks. This segment of the foreign exchange market has come to exert a greater influence on currency trends and values as time moves forward.