How the Forex Market is Structured
Banks, brokers, companies, hedge funds, market makers, etc. All are present in the forex market. Let’s have a closer look at how the forex market is structured.
For you to have a better idea, we will take a look at the market that many are very familiar with: the stock market.
This is what the structure of the stock market looks like:
“I have no choice but to go through a centralised market!”
By its very nature, the stock market is very monopolistic. Since there is only one body, the prices are controlled by a specialist. All operations must pass through this specialist; as a result of this, prices can easily be manipulated to benefit the specialist, and not the retail investors or traders.
How does this happen?
In the stock market, the specialist is bound to execute the order of his client. Now, suppose the number of sellers exceeds that of the buyers. The specialist, who is bound to execute the request of his clients (the sellers, in this case), keeps a package of shares he cannot sale to the buyer side.
To prevent this, the specialist will increase transaction fees or spreads the spread to prevent sellers from entering the market. In other words, the specialist can easily manipulate the quotes they offer, at their convenience.
The Forex market operation is decentralised
Unlike trading futures or stocks, with the forex market you don’t have to go through a centralised market, like the New York Stock Exchange with one price. In the Forex market, there is no distinct or single price for a given currency, which means that the quotes of different currencies can vary from one broker to another.
So many choices!
One might feel intimidated at first, but that’s what makes the Forex market so scary and at the same time attractive! The Forex market is very vast and the competition between brokers so fierce that you almost get the best price for the transaction. And tell me: who doesn’t want that?
The Forex market scale
Although the Forex market is decentralised, it is not just unrestrained chaos. Its stakeholders can be classified according to a value scale. Here is an illustration, to better understand this more:
At the peak of the Forex scale is the interbank market. It comprises of the world’s largest banks as well as smaller banks, with the participants of this market operating directly with each other through Electronic Agents Services (EBS) or the Reuters Dealing 3000-Spot Matching platform.
The competition between the two companies (EBS and Reuters Dealing 3000-Spot Matching) is similar to that between sporting giants, Nike and Adidas.
They are in firm battle to obtain clients and try to outsmart each other by the presence in the market, although both companies provide the majority of currency pairs, some pairs are more liquid than others.
For the EBS platform, the pairs EUR /USD, USD / JPY, EUR / JPY, EUR / CHF and USD / CHF are more liquid.
Meanwhile, for the Reuters platform, the pairs GBP / USD, EUR / GBP, USD / CAD, AUD / USD and NZD / USD are more liquid.
All banks involved in the interbank market can see the rates offered by others, but this does not imply that anyone can make transactions at those prices. As in reality, the exchange rates offered depends mainly on the credit relationship between the operating parties.
It’s like seeking a loan from your local bank, the better position and reputation you have with them, the better the interest rate and the higher the loan they give you.
The next level on the ladder is Hedge Funds, Corporations, Retail market makers and Retail ECNs.
As these institutions do not have shut credit relationships with the associates of the interbank market, they must build their transactions through the commercial banks. This implies that their rates are somewhat higher and also expensive than those of the interbank market.
The retail operators at the base of the scale. It used to be very demanding for small operators to participate in the Forex market, but thanks to the internet, retail agents, electronic operations, all the blockade that complicated the entry into FOREX operations have been demolished.
Now we know the structure of the FOREX market.