volumes. But this massive market was unknown and unavailable to most individual traders and investors until the early 2000s.
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, we take a look at how the FX market is structured and who the major players are. Along the way, we clue you in to how they go about their business and what it means for the market overall.
If you believe that information is the lifeblood of financial market trading, which we certainly do, we 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 “currency market,” they’re 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 (in the hundreds of millions) 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 we would say size really doesn’t matter. We’ve seen spot traders be right with million-dollar bets, and sophisticated hedge funds be wrong with half-billion-dollar bets.
www.bis.org.
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.
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. (See Chapter 14 for more about currency futures.)
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, as investment banks remained focused more on stocks and bonds. But the financial industry has undergone a tremendous consolidation over the last 25 to 30 years, as bank merger after bank merger has seen famous names subsumed into massive financial conglomerates. Just 20 years ago, there were over 200 banks with FX trading desks in New York City alone. Today that number is well below a hundred. But overall trading volumes have steadily increased, a testament to the power of electronic trading.
Currency trading today is largely concentrated in the hands of about a dozen major global financial firms, such as UBS, Deutsche Bank, Citibank, JPMorgan Chase, Barclays, and Goldman Sachs, to name just a few. Hundreds of other international banks and financial institutions trade alongside the top banks, and all contribute liquidity and market interest.
Bank to bank and beyond
The interbank market is a network of international banks operating in financial centers around the world. The banks maintain trading operations to facilitate speculation for their own accounts, called proprietary trading or just prop trading for short, and to provide currency trading services for their customers. Banks’ customers can range from corporations and government agencies to hedge funds and wealthy private individuals.
Trading in the interbank market
The bulk of spot trading in the interbank market is transacted through electronic matching services, such as EBS and Reuters Dealing. Electronic matching services allow traders to enter their bids and offers into the market, hit bids (sell at the market), and pay offers (buy at the market). Price spreads vary by currency pair and change throughout the day depending on market interest and volatility.
The matching systems have prescreened credit limits, and a bank will only see prices available to it from approved counterparties. Pricing is anonymous before a deal, meaning you can’t tell which bank is offering or bidding, but the counterparties’ names are made known immediately after a deal goes through.
The rest of interbank trading is done through currency brokers, referred to as voice brokers to differentiate them from the electronic ones. Traders can place bids and offers with these brokers the same as they do with the electronic matching services. Prior to the electronic matching services, voice brokers were the primary market intermediaries between the banks.
Stepping onto a currency trading floor
Although trading rooms in the large banks have shrunk since the 2008–2009 financial crisis, interbank trading rooms can still be lively and are staffed by a variety of different market professionals, each of whom has a different role to play. The typical currency trading room has
Flow traders: Sometimes called execution traders, these are the market-makers, showing two-way prices at which to buy and sell, for the bank’s customers. If the customer makes a trade, the execution trader then has to cover the resulting deal in the interbank
