Daily Forex #11 - Who Trades Forex?
There are many players in the forex market:
Banks
The greatest volume of currency is traded in the interbank market. This is where banks of all sizes trade currency with each other and through electronic networks. Banks come in assorted varieties, ranging from local credit unions to international investment banks. When banks act as dealers for clients, the bid-ask spread represents the bank's profit. Speculative currency trades are executed to profit on currency fluctuations. Interbank lending constitutes much of the global currency trade, and is used to limit risk exposure.
Central Banks
Central banks are extremely important players in the forex market. A nation’s central bank is commissioned with establishing the monetary policy of the domestic economy. Central banks set interest rates upon the local currency and directly influence the money supply of a nation.
Central banks (as well as governments and speculators) may engage in currency interventions to make their currencies appreciate or depreciate.
Investment Managers and Hedge Funds
After banks, portfolio managers, pooled funds and hedge funds make up the second-biggest collection of players in the forex market. Investment managers trade currencies for large accounts such as pension funds and endowments. An investment manager with an international portfolio will have to purchase and sell currencies to trade foreign securities as a means of both balancing risk and achieving capital appreciation.
Corporations
Firms engaged in importing and exporting conduct forex transactions to pay for goods and services. Consider the example of a German car producer that imports Japanese spare parts and sells the assembled cars in America. After the final sale is made, the American Dollar must be converted back to Euros. The German corporation must exchange Euros for Japanese Yen to purchase the Japanese spare parts.
Companies trade forex to hedge the risk associated with foreign currency translations. The same German corporation might purchase Japanese Yen in the spot market, or enter into a currency swap agreement to obtain Yen in advance of purchasing spare parts from the Japanese company in order to reduce foreign currency exposure risk.
Individual Investors
The largest number of forex participants, individuals, are actually responsible for only a fraction of the overall traded volume.The volume of trades made by retail investors is extremely low compared to that of banks and other financial institutions. But the forex trading is growing rapidly in popularity.
Retail investors base currency trades on a combination of fundamentals (interest rate parity, inflation rates, monetary policy expectations, etc.) and technical factors (support, resistance, technical indicators, price patterns).
Clearly, forex market participants trade currencies for very different reasons. Speculative trades - executed by banks, financial institutions, hedge funds and individual investors - are profit motivated. Central banks move forex markets dramatically through monetary policy, exchange regime setting, and, in rare cases, currency intervention. Corporations trade currency for global business operations and to hedge risk.
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Here are some interesting topics to start you off :
- Daily Forex #1 - Will Forex Trading Be Banned
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- Daily Forex #6 - What Makes The Price Move
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