Forex Market Participants – Who Trades Forex and Why?
Who trades Forex?
The Forex market is such a large place. It’s the largest global market with millions of participants. I don’t know about you, but hardly any of my friends or family know what is Forex. So who are all these Forex traders, and why are trading? In this chapter we’re going to breakdown the market participants into groups and talk about who trades Forex.
The most obvious answer to “who trades forex” is the banks. They deal with global transactions everyday and actually provide most the liquidity to make the big dollar transactions happen.
The largest banks in the world are connected together to make up the ‘interbank network’. The interbank network experiences the greatest amount of Forex transactions. The banks on the interbank network set the BID and ASK prices according to the supply or demand for a certain currency. The difference between the BID and ASK prices is called the spread, and this represents their profit from the transactions.
The banks are the ones with the money. Banks provide the means of Forex transactions for their customers. Retail brokers are connected to multiple banks for accessible liquidity, this also allows brokers to provide you leverage on your trades by letting you temporarily borrow and use the banks money to open larger trading positions.
Despite what you think, banks do very little speculative trading from their own dealing desks to profit from market movement. The banks main job is to be the “market makers”, they use their large amounts of cash to provide liquidity for their clients to trade. The banks make commission on the liquidity they provide.
Central banks play a key importance in the Forex market. Each central bank plays a key role in the value, and stability of their home currency. These central banks are regularly involved in influencing their currency’s foreign exchange rates to a great extent through interest rate changes, government policies and direct market intervention.
The central banks will either peg the value of their home currency to the value of another currency, or have it “floating”. Floating rates are the most common and give us the opportunity we need to make money on currency price changes. We’ve have recently seen the Swiss National Bank ‘peg‘ it’s Swiss Franc to the value of 1.2 EUROs. This action was taken as the Swiss Franc’s value was rising so much that it was killing their import/export industry.
The Bank of Japan has also been intervening in the Foreign Exchange market by aggressively selling its Yen to weaken its value. As Japan relies heavily on its import/export sector the country can’t afford to have a strong yen, so action must be taken to stop the country’s economy from sinking.
Companies must use the Forex market to conduct their everyday business. When Toyota in America needs to order parts from their manufacture in Japan, they need to exchange their USD’s for Japanese Yen. If wal-mart needs to order rubber duck toys from china, US dollars are exchanged for Chinese Yuan. These are example of commercial business that take place over the foreign exchange.
Commercials are the “hedgers” in the market. Hedging is a Forex trading strategy that takes the opposite direction to the overall trend, or forecasted price movement. It sounds suicidal, but they do this to protect themselves from currency fluctuations. If an Australian company ordered some goods from their Chinese manufacture and the Australian Dollar was gaining value at the time, the company will open up a short hedge trade.
When it’s time to pay the Chinese, any increases in the Australian Dollar value will result in a loss on the actual trade, but will be offset by the cheaper exchange rate due to the stronger Australian Dollar.
Now if the Australian Dollar weakens then the exchange rate will become more expensive but will be offset by the trade’s profits. This seems a bit strange but companies do this to protect themselves against unnecessary losses from unexpected exchange rate changes.
The Large Speculators
When we think who trades Forex, we generally think about the speculators. Speculators are broken down into two groups. The large and the small. The difference really coming down to how deep their pockets are.
The large speculators are made up of hedge funds, fund managers, insurance and superannuation companies Basically any large business that uses the market to generate a profit. Large speculators are market speculators which means they buy what they think is going to rise in value and sell what they believe will depreciate in value.
Large specs ride in the direction of the trends in the market and have been branded the ‘smart money’.
The Small Speculators
Who trades Forex? We do! The “small specs”. We are the individual “retail traders” who are also in the game to make money from money. Small specs are made up of traders like you and I. We have a much smaller impact on the market movement because our net worth in the overall market is very small compared to the commercial companies and the large speculators.
It is known that most small speculators are losers and sometimes referred to as the “dumb money”, with figures like 95% of forex traders are losing money. We use price action signals to usher us into trades. Price action trading is the most tried and tested over the years and still produces good results.
Generally it’s not the selection of trading strategy that unravels a traders chances of success. It’s mostly faults from a psychological aspect as the market plays with a traders head. This causes traders to continuously make the same forex trading mistakes.