Foreign Exchange Market Participants

July 3, 2018

The $5 trillion dollar Forex market witnesses a lot of market participants. However, all of these participants have different motives. An understanding of these motives is required to predict their behavior in the markets. Also, some of these participants have deeper pockets, better information and are more active than the others. 

 

 

 

There are various participating entities taking part in forex trading. The main players or the main market participants in currency exchange are Central Banks, largest investment firms or commercial bank, hedge funds, mutual funds and retail forex brokers etc.

 

Participants in Foreign Exchange Market:


Participants in Foreign exchange market can be categorized into five major groups, viz.; commercial banks, Foreign exchange brokers, Central bank, MNCs and Individuals and Small businesses.

  • Central Banks:

    • Central banks are extremely important players in the forex market. Open market operations and interest rate policies of central banks influence currency rates to a very large extent.
       

    • Central banks are responsible for forex fixing. This is the exchange rate regime by which a currency will trade in the open market.
       

    • Floating, fixed and pegged are the types of exchange rate regimes. Any action taken by a central bank in the forex market is done to stabilize or increase the competitiveness of that nation's economy.
       

  • Small Business or Investors: 

    • Small businesses also use foreign exchange market to facilitate execution of commercial or investment transactions.
       

    • The foreign needs of these players are usually small and account for only a fraction of all foreign exchange transactions. Even then they are very important participants in the market. Some of these participants use the market to hedge foreign exchange risk.
       

    • Hedgers: There are many businesses which end up creating an asset or a liability priced in foreign currency in the regular course of their business. For instance, importers and exporters engaged in foreign trade may have open positions in several foreign currencies. They may therefore be impacted if there is a fluctuation in the value of foreign currency. As a result, to protect themselves against these losses, hedgers take opposite positions in the market. Therefore if there is an unfavorable movement in their original position, it is offset by an opposite movement in their hedged positions. Their profits and losses and therefore nullified and they get stability in the operations of their business.
       

  • Commercial Banks: 

    • The major participants in the foreign exchange market are the large Commercial banks who provide the core of market. As many as 100 to 200 banks across the globe actively “make the market” in the foreign exchange.
       

    • These banks serve their retail clients, the bank customers, in conducting foreign commerce or making international investment in financial assets that require foreign exchange.
       

    • These banks operate in the foreign exchange market at two levels. At the retail level, they deal with their customers-corporations, exporters and so forth.
       

    • At the wholesale level, banks maintain an inert bank market in foreign exchange either directly or through specialized foreign exchange brokers.
       

  • Foreign Exchange Brokers:

    • Foreign exchange brokers also operate in the international currency market. They act as agents who facilitate trading between dealers.
       

    • Unlike the banks, brokers serve merely as matchmakers and do not put their own money at risk.
       

    • They actively and constantly monitor exchange rates offered by the major international banks through computerized systems such as Reuters and are able to find quickly an opposite party for a client without revealing the identity of either party until a transaction has been agreed upon. This is why inter-bank traders use a broker primarily to disseminate as quickly as possible a currency quote to many other dealers.
       

  • MNC:

    • MNCs are the major non-bank participants in the forward market as they exchange cash flows associated with their multinational operations.
       

    • MNCs often contract to either pay or receive fixed amounts in foreign currencies at future dates, so they are exposed to foreign currency risk.
       

    • This is why they often hedge these future cash flows through the inter-bank forward exchange market.
       

  • Retailers:

    • The retail market designates transactions made by smaller speculators and investors.
       

    • Speculators are a class of traders that have no genuine requirement for foreign currency. They only buy and sell these currencies with the hope of making a profit from it. 
       

    • The number of speculators increases a lot when the market sentiment is high and everyone seems to be making money in the Forex markets.
       

    • Speculators usually do not maintain open positions in any currency for a very long time. Their positions are transient and are only meant to make a short term profit.
       

    • These transactions are executed through forex brokers who act as a mediator between the retail market and the interbank market. Individual traders or investors trade forex on their own capital in order to profit from speculation on future exchange rates. They mainly operate through forex platforms that offer tight spreads, immediate execution and highly leveraged margin accounts.

 

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