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As opposed to the stock market which is mostly accessible only to institutional investors (like banks or corporations) or the selected few – currency market involves many players who engage in activities on foreign exchanges for reasons different from those on the stock market. While stock market is mainly approached by investors for no purposes other than profit in the long-term perspective, which may be represented by dividends on selected stocks or simply profiteering from selling high-grade stocks, foreign exchange market is generally accessible to the broader public. The thing is that the entry barriers for accessing this market were dismounted with the emergence of online forex brokerages who introduced forex trading to the general public. However, individual traders still constitute very small fraction of the foreign exchange market.
The volume of trades made by this group of traders is extremely small compared to other financial institutions. And while the forex trading is growing in popularity at exponential pace, small traders are unlikely to become the biggest player on the foreign exchange market as most of the individual traders work on leveraged accounts and frequently have no access to such stupendous amounts of capital that banks and other institutions have.
The reasons driving the forex market participants to engage in trading are different across parties involved. While financial institutions, hedge funds and individual investors do it for no reasons other than making profit, central banks act as regulators of economic activity and move currency prices in line with monetary policy targets. This may be necessary when the economy is stagnating or when inflation is too high. In any case, the first group of participants should be well aware of whatever policy changes central banks might have on the table.
Banks are the biggest players on the foreign exchange market in terms of volume. The electronic networks where all transactions between banks are processed and finalized is called the interbank market – a top level foreign exchange network where banks can deal with one another directly or through electronic brokering services. Banks conduct trading on the forex market for their clients and at the same frequently engage in speculative activities in an attempt to capitalize on currency movements. When acting as a dealer on client’s request, the bid-ask spread (difference between bid and ask price) is usually representing the bank’s profit from trader’s transactions. As such, bank’s motives and interests rarely conflict with those of traders as their profit is directly dependent on the volume of trades they make for their clients.
Central banks can be considered the most important party on the forex market. The policies they implement and tools they use in order to maintain economic stability influence currency rates to a very large extent.
Any policy changes took by central bank are done to stabilize the economy when it takes the wrong turn. For example, central banks frequently engage in so called open market operations where they buy securities from other banks in order to provide additional economic stimulus. During periods of deflationary worries, central bank for example may increase the supply of money circulating in the economy. This weakens the domestic currency, but lowers the borrowing costs and make exports of domestic goods and services more competitive on the global markets. Also, central banks effectively watch key economic indicators like employment level and inflation in order to maintain its target interest rate which can be changed whenever the bank feels appropriate. All projected interest rate changes are usually introduced and spoken about long before the actual rate change actually takes place which gives traders time to make preparations.
Companies involved in global trade are active participants of the foreign exchange market. Imagine you’re a purchasing manager in a Chinese car-manufacturing company which imports vital components from let’s say Japan and sells the final product in different markets. Reliance on Japanese components makes it necessary to convert Chinese Yuan into Japanese YEN in order to complete the purchase of parts. As such, any transaction of similar nature implies purchase of foreign currency and affects rates to some extent.
Companies also trade forex to hedge the risk associated with foreign currency translations. The same Chinese company might purchase American dollars in the spot market, or enter into a currency swap agreement to obtain the YEN in advance of purchasing components from the Japanese company in order to reduce foreign currency exposure risk.
Every party matters
The resulting collaboration between participants of the market impacts the value of the currencies being traded and forms shape the global economy. While the fraction of individual traders is small comparison to other parties on this market, this educational course is targeted mostly towards this group of people who are looking for an opportunity to trade with a forex broker of his or her choice. The importance of other players should never be underestimated by individual traders who should be well- educated in the matter and follow the news related to central banks and other institutions.