are also responsible for watching and executing customer orders in the market. These are the traders who are generating most of the electronic prices and price action.
Proprietary traders: These traders are focused on speculative trading for the bank’s own account. Their strategies can run the gamut from short-term day trading to longer-term macroeconomic bets. In the wake of the 2008–2009 financial crisis and changes to regulation such as the Volcker Rule, there has been a sharp decline in banks’ trading for their own accounts, and many proprietary trading desks have closed down or moved to hedge funds.
Forward traders: Forward traders are active in the forward currency market, which refers to trades made beyond the normal spot value date. The forward market is essentially an interest rate differential market, where the interest rates of the various currencies are traded. These traders provide the bank’s customers with pricing for non-spot deals or currency swap agreements. They also manage the bank’s interest rate exposure in the various currencies.
Options traders: Options traders manage the bank’s portfolio, or book, of outstanding currency options. They hedge the portfolio in the spot market, speculate for the bank’s own account with option strategies, and provide pricing to the bank’s customers on requested option strategies. (Flip to Chapter 15 for more about currency options.)
Sales staff: The sales staff acts as the intermediary between the trading desk and the bank’s customers. They advise the bank’s customers on market flow, as well as who’s buying and selling; recommend spot and option trading strategies; and execute trades between the bank and its customers.
Hedgers and Financial Investors
The forex market sits at the crossroads of global trade and international finance and investing. Whether it’s a U.S. conglomerate managing its foreign affiliates’ balance sheets or a German mutual fund launching an international stock fund, they all have to go through the forex market at some point.
The lion’s share of forex market turnover comes from speculators. Market estimates suggest that upwards of 90 percent of daily FX trading volume is based solely on speculation. We look at the types and roles of speculators later in this chapter, but here we want to introduce the players who are active in the forex markets for nonspeculative reasons.
Financial transactors are important to the forex market for several reasons:
Their transactions can be extremely sizeable, typically hundreds of million or billions.
Their deals are frequently one-time events.
They are generally not price sensitive or profit maximizing.
Hedging your bets
Hedgers come in all shapes and sizes, but don’t confuse them with hedge funds. (Despite the name, a hedge fund is typically 100 percent speculative in its investments.)
Hedging is about eliminating or reducing risk. In financial markets, hedging refers to a transaction designed to insure against an adverse price move in some underlying asset. In the forex market, hedgers are looking to insure themselves against an adverse price movement in a specific currency rate.
Hedging for international trade purposes
One of the more traditional reasons for hedging in the forex market is to facilitate international trade. Say you’re a widget maker in Germany and you just won a large order from a UK-based manufacturer to supply it with a large quantity of widgets. To make your bid more attractive, you agreed to be paid in British pounds (GBP).
But because your production cost base is denominated in euros (EUR), you face the exchange rate risk that GBP will weaken against the EUR. That would make the amount of GBP in the contract worth fewer EUR back home, reducing or even eliminating your profit margin on the deal. To insure, or hedge, against that possibility, you would seek to sell GBP against EUR in the forex market. If the pound weakened against the euro, the value of your market hedge would rise, compensating you for the lower value of the GBP you’ll receive. If the pound strengthens against the euro, your loss on the hedge is offset by gains in the currency conversions. (Each pound would be worth more euros.)
Trade hedgers follow a variety of hedging strategies and can utilize several different currency hedging instruments. Currency options can be used to eliminate downside currency risk and sometimes allow the hedger to participate in advantageous price movements. Currency forward transactions essentially lock in a currency price for a future date, based on the current spot rate and the interest rate differentials between the two currencies.
Trade-related hedging regularly comes into the spot market in two main forms:
At several of the daily currency fixings: The largest is the London afternoon fixing, which takes place each day at 4 p.m. local time, which corresponds to 11 a.m. eastern time (ET). The Tokyo fixing takes place each day at 8:55 a.m. Tokyo time, which corresponds to 6:55 p.m. eastern time (ET). A fixing is a process where commercial hedgers submit orders to buy or sell currencies in advance. The orders are then filled at the prevailing spot rate (the rate is fixed) at the time of the fixing. The difference between the amount of buying and selling orders typically results in a net amount that needs to be bought or sold in the market prior to the fixing time. On some days, this can see large amounts (several billion dollars or more) being bought or sold in the hour or so leading up to the fixing time. After the fix, that market interest has been satisfied and disappears. Month-end and quarter-end fixings typically see the largest amounts of volume. Short-term traders need to closely follow live market commentaries to see when there is a substantial buying or selling interest for a fixing. (See Chapter 2 for more on potential future changes to the fixing process.)
Mostly in USD/JPY, where Japanese exporters typically have large amounts of USD/JPY to sell: Japanese exporters receive dollars for their exports, which must then be converted into JPY (sell USD/buy JPY). The Japanese export community tends to be closely knit and their orders are likely to appear together in large amounts at similar levels. Again, real-time market commentaries are the most likely source for individual traders to hear about Japanese exporter selling interest.
Hedging for currency options
The currency option market is a massive counterpart to the spot market and can heavily influence day-to-day spot trading. Currency option traders are typically trading a portfolio of option
