The Foreign Exchange – Sweeter Than You

Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is comprises the largest commercial banks and securities dealers. Within the inter-bank market, spreads, which are the difference between the bids and ask prices, are razor sharp and not known to players out of the inner circle. The difference between the bid and ask prices broadens (for example from 0-1 pip to 1-2 pips for a currencies such as the USD) as someone goes down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for huge amounts, they can claim 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 controlled by the size of the line (the amount of money with which they are carrying out trade). The top-tier bank to bank market accounts for 53% of all transactions. After that there are usually smaller banks, followed by many multi-national corporations (which need to hedge he setback and pay employees in different countries), large hedge funds, and even some of the retail foreign exchange market makers.

According to Galati and Melvin, Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly substantial role in monetary markets in general, and in foreign exchange markets in particular, since the early 2000s. (2004) In addition, he notes, Hedge funds have grown noticeably over the 2001 - 2004 period in terms of both number and overall size. Central banks also take part in the foreign exchange market to align currencies to their economic needs.

Banks: The interbank market caters for both the majority of commercial turnover and huge amounts of speculative trading every day. A large bank may trade billions of dollars everyday. Some of this trading is undertaken on behalf of customers, but much is carried out by proprietary desks, trading for the banks own account. Until recently, foreign exchange brokers did huge amounts of business, facilitating interbank business and matching anonymous take on large fees. Today, however, much of this business has rushed on to more efficacious electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is mentionably smaller than just a few years ago.

Commercial companies a significant 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 in comparison with those of banks or speculators, and their trades often have little short term influence on market rates. Nevertheless, trade flows are an significant factor in the long-term direction of a currencys exchange rate. Some multinational companies can have an unpredictable influence when very large positions are covered due to exposures that are not widely known by other market participants.

Central banks: National central banks have an important role in the foreign exchange markets. They try to rein 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 make the stable the market. Nevertheless, the effectiveness of central bank stabilizing speculation is susceptible 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.