When you trade forex it feels that the whole world is focused on you and maybe a little bit on your forex broker. In reality forex market consists of much larger entities than 1 profit-thirsty trader and spread-seeking forex broker. Today’s topic of discussion is who is involved in forex trading and why should you care?
We are definitely not alone in forex market and it is wise to get up close and personal with the players behind the scene.
1. Federal Governments and Central Banks
Federal governments and central banks play major role in currency exchange. These two are like dancing couple, making extravagant moves along the forex market hand in hand. Government representatives meet up with Central Banks representatives regularly to discuss the money issues. And even if others may argue, federal governments and central banks always seem to be in agreement with each other. After all, these forex players are able to manipulate forex market in order to meet any kind of economic agenda.
2. Financial Institutions and Other Banks, Besides Central Banks
Central Banks are not the only banks known to man kind. Other financial institutions are also considered big shots in forex market.
Before we go any further with this, let’s understand the concept of interbank market. Interbank market is the market where banks make transactions with one another and fix the currency price that you, forex trader, see on your trading platform. The transactions these large banks engage in are based upon credit relationship. The more credit relationships bank has, the better currency rates it can provide for its forex traders. So, basically, it is safe to say that Banks are like dealers. That is a reason why different banks have different currency rates. Remember those days when forex trading was not yet available online? Currency exchange were done solely in banks or currency exchange points and all of them would have their own “special” currency rates.
3. Moving On - Hedgers
Who are the major clients of large banks? Well, of course well established, successful businesses with international transactions. International businesses need to either buy from or sell their product or services to an international client and that directly brings us to forex market.
The problem every international business faces is the ambiguity in currency rates. Imagine that you are an owner of a very profitable international business in America. Now, you have found out that the equipment you need for your business is much cheaper in Japan. So you order the equipment and you schedule the payment for the equipment half a year from now (it takes that long for the equipment to be installed!). Do you see the problem yet? Let me elaborate. The exchange rate change constantly and there is no way of knowing what will happen over half a year from now. Maybe you will end up overpaying at the time of delivery.
No problem, you might say. International business can simply make immediate transaction for the needed foreign currency via forex market. Yes, that is correct, but what if there is not enough money at the moment?
That’s where hedging comes in handy. Hedging strategies allow you to secure an exchange rate at the time of the business deal. This eliminated the risk of dealing with foreign currency.
4. Currency Speculators
In general, currency speculation is defined as “assumption of the risk of loss, in in return for the uncertain possibility of a reward”. Speculators take advantage of unpredictable exchange rates. The biggest speculators of them all are hedge funds. Hedge funds use all kind of forex strategies to gather large returns. It’s like betting, really. Speaking of which, here is a proof that forex has an element of gambling!
Do you feel like a tiny ant surrounded by prehistoric dinosaurs? Don’t let it scare you. The beauty of forex market is that there is enough in it for every one, even you and your forex broker!