Chapter 3
Who Trades Currencies? Meet the Players
In This Chapter
Understanding where currency rates come from
Stepping onto a trading floor
Hedging and investing through the forex market
Understanding that speculating is the name of the game
Managing foreign currency reserves
The forex market is regularly referred to as the largest financial market in the world based on
trading volumes. But this massive market was unknown and unavailable to most individual traders
and investors until the late 1990s.
That leaves a lot of people in the dark when it comes to exactly what the currency market is: how
it’s organized, who’s trading it, and why. In this chapter, I discuss how the FX market is structured
and who the major players are. Along the way, I clue you in to how they go about their business
and what it means for your trading in the currency market.
If you believe that information is the lifeblood of financial market trading, which I certainly do, I
think you’ll appreciate this guide to the movers and shakers of the currency market. When you have
a better understanding of who’s active in the FX market, you’ll be able to make better sense of
what you see and hear in the market.
The Interbank Market Is “The Market”
When people talk about the forex market, they’re usually referring to the interbank market,
whether they realize it or not. The interbank market is where the really big money changes hands.
Minimum trade sizes are one million of the base currency, such as €1 million of EUR/USD or $1
million of USD/JPY. Much larger trades of between $10 million and $100 million are routine and
can go through the market in a matter of seconds. Even larger trades and orders are a regular
feature of the market.
For the individual trading FX online, the prices you see on your trading platform are based on the
prices being traded in the interbank market.
The sheer size of the interbank market is what helps make it such a great trading market because
investors of every size are able to act in the market, usually without significantly affecting prices.
It’s one market where I would say size really doesn’t matter. I’ve seen spot traders be right with
million-dollar trades, and sophisticated hedge funds be wrong with half-billion-dollar positions.
Daily trading volumes are enormous by any measure, dwarfing global stock trading volumes
many times over. The most recent Bank of International Settlement (BIS) report, released in
2010, estimated daily FX trading volumes of nearly $4 trillion.
Getting inside the interbank market
So what is the interbank market, and where did it come from? The forex market originally evolved
to facilitate trade and commerce between nations. The leading international commercial banks,
which financed international trade through letters of credit and bankers’ acceptances, were the
natural financial institutions to act as the currency exchange intermediary. They also had the
foreign branch network on the ground in each country to facilitate the currency transfers needed to
settle FX transactions.
The result over years was the development of an informal interbank market for currency trading.
As the prefix suggests, the interbank market is “between banks,” with each trade representing an
agreement between the banks to exchange the agreed amounts of currency at the specified rate on a
fixed date. The interbank market is alternatively referred to as the cash market or the spot market
to differentiate it from the currency futures market, which is the only other organized market for
currency trading.
Currency futures markets operate alongside the interbank market, but they are definitely the tail
being wagged by the dog of the spot market. As a market, currency futures are generally limited by
exchange-based trading hours and lower liquidity than is available in the spot market.
The interbank market developed without any significant governmental oversight, and it remains
largely unregulated to this day. In most cases, there is no regulatory authority for spot currency
trading apart from local or national banking regulations. Interbank trading essentially evolved
based on credit lines between international banks and trading conventions that developed over
time.
The big commercial banks used to rule the roost when it came to currency trading, whereas
investment banks remained focused more on stocks and bonds. But the banking industry has
undergone a tremendous consolidation over the last 20 years, as bank merger after bank merger
has seen famous names subsumed into massive financial conglomerates. Today it’s hard to even
think of the major banks as either commercial banks or investment banks, such has been the
expansion of their trading operations.
While banks formed the core of the interbank market for decades, nonbank financial institutions,