Who trades in the Forex Market?

Who are the participants in the gigantic market of Forex?

This market, the biggest in the world, although not for retail traders, no matter what some people say, are composed of many components.

To get the idea, the participants of this market range from the tourist who buys in the street until the central banks and their massive purchases, including the dealings of big companies.

The Forex market structure is not much different of that of a pyramid

It is clear, is not it?

Let us have a look to the characteristic of this market in comparison with other similar markets like stocks or futures.

Centralized markets

In the centralized markets, like stocks, we have regulators like NYSE, the SEC, the NFA, etcetera, which are in charge of the legal aspects of every transaction you do in those markets and, of course, make sure that every trade is done in a proper way, in other words at a market price.

According to some people, this is a monopolistic market not very good for traders because it is supposed that as there is only one centralized market there is not enough competition so the traders can have good prices, besides the fact that the prices can be, supposedly, more easily manipulated.

That is true: if there is a monopoly it is easier to manipulate.

That is clear.

However, the fact that the stock market is centralized does not mean that it is bad or it is manipulated more than other market is, at least not in a way that affects traders seriously.

On the contrary, the centralized market provides a great advantage over other non centralized markets, and that is that the trades that take place are recorded and kept in a historic book which the authorities have access to. Therefore it is difficult for a broker to do strange things with the trades of its customers.

For example, if Apple trades at 125 as the minimum price of the day, which is the minimum we could have bought at, period.

The bid and ask, in other words, the spreads we use for buying and selling are the same for all the participants since all dealers have to trade through the centralized market.

The only way we can have different prices is when we use synthetic markets, like CFDs, Forex or binary options.

The decentralized Forex market

The Forex market, contrary to the stock market one, is a decentralized one since the market takes places in different parts of the world and different places, like a shop in Bangkok or a deal in the Swiss Central Bank.

As you can see there are thousands and millions of “markets” in the Forex market, one per each transaction.

The market that is the guide for prices is the interbank one, although you will not be able to trade in that one, of course.

In any case you will be able to open an account in a retail broker and trade at retail prices.

The broker takes as a reference the interbank prices but it does not mean that the prices are the same since the broker will use the spread and price that it considers adequate.

Therefore, the supposed advantage of having decentralized markets and its bigger competition between its components is not such an advantage after all.

Forex market structure

The structure of this market is similar to a pyramid, with a sort of “allseeingeye” being the central banks, and the base being the tourists and individual traders.

Let us have a look to that pyramid:

  1. Big Central Banks and big corporations: Goldman Sachs, FED, BCE, etcetera.
  2. Companies responsible for electronic trading: EBS or Reuters Dealing 3000
  3. Medium and small banks
  4. Market maker brokers, ECN, Hedge Funds, Funds and commercial companies like Toyota or Nike, for example.
  5. Retail individuals.

As you can see the pyramid is quite big and includes countless participants, not only in the number of individual traders but also the great amount of corporations that participate.

When you use the Forex market you are in the base of the pyramid and your conditions are very different to those of banks.

Let us say that Barclays acts as a dealer.

Barclays buys and sells with J.P. Morgan, for example.

These banks put their liquidity at the disposal of the big companies of the world that need to carry their daily operations.

Some of those companies are brokers.

These brokers decide to put their liquidity at the disposal of the potential forex traders offering some “in-house prices”.

In this case some ECN brokers can actually be taking liquidity from market makers.

If the original market maker decides to increase the spread 50 pips for some reason, the “ECN broker” will do the same.

If you ask them why they did that, they will answer that it was what their liquidity providers offered them.

In this way, different ECN brokers have different conditions.

What is more, some ECN brokers could even change their conditions if they think that the market disruption can be too big.

In reality you have no chance of verifying if what you see is true or not.

In the futures or stock markets, on the contrary, you can see the price that every asset has had any given day because those prices are registered in the regulator book.

If you buy in a currency exchange shop in London then the transaction keeps in their book and you have a receipt, but it is just another transaction in the decentralized market.

The same occurs with the Forex broker, whether market maker or ECN.

I do not mean that the Forex market is bad per se, because it has good trading opportunities, but just wanted to emphasize that things are not what they seem or what they are told at first glance.

The Forex market has its advantages and disadvantages, as any other market.

Regards and good trading.

This is a translation of my original article in Spanish: ¿Quien negocia en el mercado Forex?

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