The Forex Marketplace

Presently, the foreign exchange market is one of the largest and most liquid financial markets in the world. Traders include large banks, central bank, currency speculators, corporations, governments, and other financial institutions.

According to the 2009 Euromoney FX Poll, total turnover has reached a record USD175.3 trillion. The market share for the top five banks remained steady, at a combined 61.5%. The combined share of the top ten banks rose, from 76.3% to 79.7%.

Unlike a stock market, where all participants have access to the same prices, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. The difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due to volume.

If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment 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 market makers.

The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. 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. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems.

Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. 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. 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
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high—that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.

The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992–93 ERM collapse, and in more recent times in Southeast Asia.

Hedge funds as speculators
About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.

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

Retail foreign exchange brokers
There are two types of retail brokers offering the opportunity for speculative trading: retail foreign foreign exchange brokers and market makers. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated by the CFTC and NFA might be subject to foreign exchange scams. At present, the NFA and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. As a result many of the smaller, and perhaps questionable brokers are now gone. It is not widely understood that retail brokers and market makers typically trade against their clients and frequently take the other side of their trades. This can often create a potential conflict of interest and give rise to some of the unpleasant experiences some traders have had. A move toward NDD (No Dealing Desk) and STP (Straight Through Processing) has helped to resolve some of these concerns and restore trader confidence, but caution is still advised in ensuring that all is as it is presented.

Non-bank Foreign Exchange Companies
Non-bank foreign exchange 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.

It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.

Money Transfer/Remittance 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 $95 billion. The largest and best known provider is Western Union with 345,000 agents globally.

There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currency instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price.

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.

One such marketplace is the Dukascopy - SWFX FX Marketplace, a technological solution for trading, using a centralized-decentralized marketplace model. The SWFX is specialized in institutional liquidity and instant execution. Among the ten FX marketplaces in the world, Dukascopy - SWFX has a unique position by combining liquidity of the biggest marketplaces. In this market, the participants act on an equal and transparent basis. Being a marketplace, the SWFX prevents conflict of interest between buyers and sellers.

Among marketplaces with a centralized structure, Dukascopy gives access to the Decentralized Marketplace (SWFX - Swiss Forex Marketplace) by combining liquidity of other marketplaces and a number of banks.

The general scheme above shows the main participants of the business model (see below). The left side includes centralized and decentralized liquidity providers. Combining their bid/offer orders in the resulting data feed, the central element is in fact the liquidity pool itself, being at the same time a centralized marketplace for its clients: liquidity consumers and centralized liquidity providers. Liquidity consumers are able to place bid/offer orders. Execution of any order in this decentralized Forex Marketplace, can take place on one of the servers - decentralized liquidity providers, or on the red - the centralized marketplace itself. The decentralized liquidity provider can be a single bank liquidity provider or any marketplace server.

As an example, End Liquidity Providers for the month of January 2009 were: Dresdner, SG Paris, Standard Chartered, Barclays Capital, Bank of America, CRNX, JPMorgan, Morgan Stanley, Deutsche Bank AG, RBS, CITI, UBS, HOTSPOT INST, HOTSPOT RETAIL, GOLDMAN, LavaFX, SWFX FX Participant, SWFX FX Anonymous Bank, Other Liquidity Providers.

In Dukascopy's case, a trader may have multiple end counterparties.

Step 1:

Step 2:

Step 3:

Step 4:


  • Hotspot FXi LLC is a wholly owned subsidiary of Hotspot FX, Inc. Hotspot FX, Inc. is a subsidiary of Knight Capital Group, Inc.
  • Currenex is a wholly owned subsidiary of State Street Corp, the world's leading provider of financial services to institutional investors. State Street has $11.9 trillion in assets under custody and $1.7 trillion under management.
  • Lava Trading is a Citigroup company.
Dukascopy produces a valuable tool, the SWFX Sentiment Index, which is based on transaction flow information and is designed to show long and short ratio in the most popular currencies and currency pairs consolidated by liquidity consumers and providers.

Liquidity consumers are represented by individual clients, brokers, investment companies and hedge funds. The sentiment ratio of this group is the percentage of longs or shorts in the overall amount of open trades, executed by the liquidity consumer. The index also includes liquidity from individual bids and offers of the foregoing participants if it is not provided on a regular basis.

Liquidity providers are participants of SWFX marketplace represented by centralized marketplaces and a number of banks which continuously provide ask and bid prices on the market (e.g. Dresdner, SG Paris, Standard Chartered, Barclays Capital, Bank of America, CRNX, JPMorgan, Morgan Stanley, Deutsche Bank AG, RBS, CITI, UBS, HOTSPOT INST, HOTSPOT RETAIL, GOLDMAN, LavaFX, SWFX FX Participant, SWFX FX Anonymous Bank, Other Liquidity Providers). The sentiment ratio of this group is opposite to liquidity consumers’ data because, for each trade executed through SWFX, there are two equal and offsetting over-the-counter transactions.

  • Liquidity consumers are extremely long when liquidity providers are extremely short (and vice versa).
  • A top in price occurs when liquidity consumers are extremely long and when liquidity providers are extremely short (and vice versa).
  • Liquidity consumers are on the right side of the market for the meat of the move but are wrong at the turn.
  • Liquidity providers are on the wrong side of the market for the meat of the move but are correct at the turn.

So, in an ocean full of different sharks... make sure that you're swimming with the right shark at the right time. Failure to do so... well, you'll be eaten up in an instant! :-)


Blogger said...

I would advise that you stick with the most recommended Forex broker - AvaTrade.

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