In our last lesson we continued our course on the basics of Forex Trading with a look at the differences between an exchange traded market like the stock market and an over the counter market like the forex market. In today's lesson we are going to continue this discussion with a look at the structure of the forex market so we can learn who exactly controls the market and how the forex broker and individual trader fit into this picture.
As we discussed in our last lesson the forex market is an over the counter market meaning that there is no centralized exchange where all trades are made. Because of this, the price that someone receives when trading forex has traditionally differed depending on the size of the transaction and the sophistication of the person or entity that is making that transaction.
At the center or first level of the market is something known as the Interbank market. While technically any bank is part of the Interbank market, when an FX Trader speaks of the interbank market he or she is really talking about the 10 or so largest banks that make markets in FX. These institutions make up over 75% of the over $3 Trillion dollars in FX Traded on any given day.
There are two primary factors which separate institutions with direct interbank access from everyone else which are:
1. Access to the tightest prices. We will learn more about transaction costs in later lessons however for now simply understand that for every 1 Million in currency traded those who have direct access to the Interbank market save approximately $100 per trade or more over the next level of participants.
2. Access to the best liquidity. As with any other market there is a certain amount of liquidity or amount that can be traded at any one price. If more than what is available at the current price is traded, then the price adjusts until additional liquidity enters the market. As the forex market is over the counter, liquidity is spread out among different providers, with the banks comprising the interbank market having access to the greatest amount of liquidity and then declining levels of liquidity available at different levels moving away from the Interbank market.
In contrast to individuals who make a deposit into their account to trade, institutions trading in the interbank market trade via credit lines. In order to get a credit line from a top bank to trade foreign exchange you must be a very large and very financially stable institution, as bankruptcy would mean the firm that gave you the credit line gets stuck with your trades.
The next level of participants are the hedge funds, brokerage firms, and smaller banks who are not quite large enough to have direct access to the Interbank market. As we just discussed the difference here is that the transaction costs for the trade are a bit higher and the liquidity available is a bit lower than at the Interbank level.
The next level of participants has traditionally been corporations and smaller financial institutions who do make foreign exchange trades, but not enough to warrant the better pricing
As you can see here, traditionally as the market participant got smaller and less sophisticated the transaction costs they paid to trade became larger and the liquidity that was available to them got smaller and smaller. In a lot of cases this is still true today, as anyone who has ever exchanged currencies at the airport when traveling knows.
To give you an idea of just how large a difference there is between participants in the Interbank market and an individual trading currencies for travel, Interbank market participants pay approximately $.0001 to exchange Euros for Dollars where Individuals in the airport can pay $.05 or more. This may not seem like much of a difference but think about it this way: On $10,000 that is $1 that the Interbank participant pays and $500 that the individual pays.
The landscape for the individual trader has changed drastically since the internet has gone mainstream however, in many ways leveling the playing field and putting the individual trader along side large financial institutions in terms of access to pricing and liquidity. This will be the topic of our next lesson.
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WEEKLY Forex Economic Calendar: 24 Feb Fri
13:30 CA- CPI
15:00 US- New Homes Sales
15:00 US- final Univ of Mich Survey
13 Feb Mon
No Major Data 27 Feb Mon
13:30 US- Durable Goods 28 Feb Tues
07:00 DE- Retail Sales
10:00 EZ- flash HICP
13:30 US- GDP
15:00 US- CB Consumer Confidence
15:30 US- EIA Crude 1 Mar Wed
All Day- final Mfg PMIs
08:55 DE- Jobless
13:30 US- PCE Deflator
15:00 CA- Bank of Canada Decision
15:30 US- EIA Crude
19:00 US- Beige Book 2 Mar Thu
13:30 US- Weekly Jobless
23:30 JP- CPI 3 Mar Fri
All-Day SVC PMIs
Markets are heading into the weekend with a risk-off posture. Worries about European elections over the next several weeks appear to be fading for the moment. On the other hand, all the hysteria about the Trump Presidency has begun to abate. The new administration is starting to learn that the U.S. political system with its checcks and balances is designed constitutionally to be slow to change.
Some have been pushing the date for a Fed rate hike back to May. I don't see much of asentiment shift in Fed Funds futures. I still feel the Fed hikes in March barring a significantly weaker than expected February jobs report on March 10. The FOMC Minutes left open the door to the RISK of a Rate hike as early as the March 15 FOMC ("fairly soon"). No clear signal was sent. The Fed would like to embark on a policy "normalization". Some have trouble believing they have the courage to go through with a rate hike. For Yellen to build market credibility, she should hike rates soon. Fed Funds futures odds for a March Fed rate hike are only 38% (34%), suggesting they are skeptical. Markets now place the odds for rate hikes by June at 112% (116%).
On top of the Fed muddle, investors have begun to worry about the risk from key leadership elections in Europe over the rest of the year. Many worry about the possibility of a swing to right as has been seen in the U.K. (Brexit) and U.S. (Trump). Such could be a challenge to the status quo in the EU.
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The forex forum is where traders come to discuss the forex market. It is one of the few places where forex traders of all levels of experience, from novice to professionals, interact on the same venue to discuss forex trading. There is also the GVI Forex, which is a private subscription service where professional and experienced currency traders meet in a private forex forum. it is like a virtual forex trading room. This is open to forex traders of all levels of experience to view but only experienced currency tradingprofessionals can post.
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Global-View.com also offers a forex blog, where articles of interest for currency trading are posted throughout the day. The forex blog articles come from outside sources, including forex brokers research as well as from the professionals at Global-View.com. This forex blog includes the Daily Forex View, Market Chatter and technical forex blog updates. In additional to its real time forex forum, there are also Member Forums available for more in depth forex trading discussions.
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