A big part of understanding any market is knowing who the market participants are and getting a handle on the structure of the market. The Forex market is the largest market by cash volume in the world, with approximately $4 trillion worth of currency changing hands every day. Unlike regulated stock markets which trade in shares of public companies, the Forex market is not centralized, with the most important participants at the top, with trades cascading down. The largest participants get the best terms and can move the market with their trades, although as the market is so big, it is difficult for any entity to manipulate. Working in order of size from the top down, the Forex field looks like this.

Central Banks

Central banks are national banks, in charge of issuing and lending the national currency. They are at the very top of the “food chain”. The usually also set monetary policy such as interest rates, and can increase or reduce the supply of their currency. They also usually have enormous reserves of other currencies and stores of value such as gold bullion. This means that they have several powers which when exercised can move the market in their currency dramatically.

Banks

Most of the market volume is traded in the interbank market, i.e. between banks. Banks trade for both themselves and for their clients, Banks trade for themselves both as a speculative ventureand to build their own inventory of currency, as well as acting as a dealer to large, professional market participants. As dealer, banks make their profit from the bid/ask spreads which they impose on exchange rates quoted to their clients.

Investment Managers and Hedge Funds

The biggest customers of the banks are speculative hedge funds and manager of other investment vehicles. They may want to exchange currencies either to finance purchases of securities denominated in currencies which they do not own, hedge against a risk in future fluctuations in currency exchange rates which could adversely affect their portfolios of securities, or simply to speculate upon such fluctuations for profit. While hedge funds trade in very large volume and get a lot of publicity, the pension fund industry accounts for a larger total of assets under management. However, as their trading style tends to be more conservative, it is the hedge funds as bigger risk-takers which tend to have a bigger influence upon the Forex market.

Retail Traders

Retail traders are at the very bottom of the chain, trading on worse terms than every other actor listed above. Retail Forex brokerages are needed to trade, and these brokers may not even be hedging their risk on our trades. If they are, they will be usually using a bank for their Forex dealing, which in turn is probably using another bank, which may then finally have behind it one of the “big four” or tier 1 banks. At each level, the prices, spreads etc. will slowly worsen.