Whenever we are looking to start a career in forex trading, it is always a good idea to have some sense of the competition. After all, trading in the financial markets will always involve both winners and losers so it is a good idea to know who might be on the other side of your forex trading positions. This is one of the best tips in dealing with forex trading for beginners so let's take a look at some of the financial entities that can influence forex prices in the markets.
FX market participants can be broadly categorized into the following segments:
- Corporates who conduct overseas business
- Consumers/individuals who travel abroad or trade FX
- Financial institutions and institutional investors who invest and trade FX
- Commercial and central banks who are involved in FX markets to trade FX or maintain countries currency rate vs. other foreign currencies
In this article, we focus on the participants who mostly trade or invest in FX markets. Corporates who conduct overseas business convert their local currency to foreign currency. They also involve in derivative FX contracts (futures, forward contracts, and swap) in order to hedge their foreign currency exposure. For example, Apple has multiple FX hedging instruments in place as it is does business in multiple countries with multiple currencies.
Individual or institutional investors require currency exchange whenever they deal in any foreign investment, be it equities, bonds, bank deposits, or real estate. For example, US investor buying Japanese stocks should hedge its position from JPY risk. They also trade currencies in order to profit from movements in the currency exchange markets.
Central Banks
Central banks are another big group of participants in FX market. They trade currencies to improve economic conditions (for example, Bank of Japan tries to weaken JPY in order to improve exports which is good for the economy) or to intervene in an attempt to adjust economic or financial imbalances. PBOC (Peoples Bank of China) also have been intervening in FX market actively for the past 2 years in order to protect RMB from sudden depreciation which might cause capital outflow from the country.
In addition to central banks, some of the largest participants involved with forex transactions are commercial and investment banks. Banks make currency transactions with each other on electronic brokering systems that are based on credit. Only banks that have credit relationships with each other can engage in transactions.
The larger banks tend to have more credit relationships, which allow those banks to receive better foreign exchange prices. The smaller the bank, the fewer credit relationships it has and the lower the priority it has on the pricing scale. Banks also act as dealers given they are willing to buy or sell a currency at the bid and ask price. One way that banks make money on the forex market is by exchanging currency at a higher price than they paid to obtain it. Since the forex market is a worldwide market, it is common to see different banks with slightly different exchange rates for the same currency.