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Interbank
The Interbank Market makes the market, for they are tier-1, top-level, were the bulk of Forex transactions take place. There would be no 'real' market if it wasn't for the 'market makers.' The currencies of most developed countries have floating exchange rates. These currencies do not have fixed values but, rather, values that fluctuate relative to other currencies. The Interbank Market is an important segment of the foreign exchange market. It is a wholesale market through which most currency transactions are channeled.
The InterBank system is were the major financial institutions of the world exchange currencies either directly or through electronic brokering platforms. Over 1,000 world banks (including, UBS, Barclays Capital, Deutsche Bank and Citigroup) are connected through one of two sources, either Reuters or EBS (Electronic Brokering Services). Professional traders working at these major banks and financial institutions trade for their employer's account and also handle very large customer business and orders mostly in the billions of dollars. The minimum contract size is USD1 million, the typical transaction size is USD5 million dollars.
The Interbank Market consists of all the large banks that deal with each other based on credit and are largely responsible for the exchange rates, which all other traders follow on their quote systems and trading platforms. The larger the credit network a particular bank has, the better will be its access to competitive foreign exchange rates. Having this larger network and access to the best rates enables traders at the bank to act as market makers, dealing on both sides of the bid/offer spread (the difference between the currency pair's base and quote price) for the bank's benefit.
Many large banks with a foreign exchange department will hire professional Forex dealers to act as market makers to their customers and other professional Interbank counterparties. They will typically 'make markets' (two-way prices consisting of a bid and an offer price) in one or more currency pairs for their customer dealing desk and for counterparties for whom the bank has extended lines of credit.
Corporations
An important type of customer that trades Forex through the dealing desk of a major Forex bank consists of large corporations looking to hedge against exchange rate risk. Other bank Forex dealing desk customers might include financial institutions like hedge funds or wealthy individuals looking to speculate on foreign exchange rate movements or shift investment funds between countries.
Multi-national corporations that need access to the foreign exchange market in order to realize profits in their home country and to purchase raw materials abroad make up another important part of the foreign exchange market. Importers and exporters also make use of the market, as well as companies, which routinely operate internationally such as automotive, airlines, and freight companies. These types of participant generally trade currencies to protect or hedge against adverse movements in the foreign exchange market where they may have exposure.
An example of this might be a United States manufacturer, which obtains key parts for their product in Japan. By trading in the Forex market, with Forwards and Futures, the manufacturer can assure obtaining the Japanese Yen needed for the ongoing purchases at the best rates, hence hedging the risk.
Hedge Fund
Global fund managers, hedge, large mutual, pension, and arbitrage funds that invest in foreign securities and other foreign financial instruments are relatively small. Although they may be small when compared to other market participants, they are the most aggressive. These groups can have substantial impacts on spot price movements as they are constantly re-balancing and adjusting their international equity and fixed income portfolios. These portfolio decisions can be influential because they often involve sizable capital transactions. A majority of the hedge funds are highly leveraged and actively seeking to profit in whichever way possible. Despite the highly criticized, sometimes devious nature of hedge funds, traders value them because they often push the markets to retract from extreme levels.
Hedge funds are used by high net worth individuals investing a minimum of $1 million. One of the best-known Hedge Funds is the George Soros Quantum Group of Funds that made a billion dollar profit by shorting the British pound in 1992.
International Funds are non-currency funds consisting of large capital, which exert substantial influence on the FX market. With more and more funds delegated to hedging activities, international funds are becoming a main driver of international capital and equities trends, which in turn, greatly affects the Forex market.
FX Fund
Funds that invest in the Forex market are commonly called Global Macro funds. These funds depending on size tend to take different positions in the FX market. Many large funds tend to carry large trade positions, exploiting global interest rate differentials. Others tend to seek out opportunities to take advantage of misguided economic policies or currencies that overshoot their real value; by entering large positions, they are speculating on a return to equilibrium. Others simply gauge global events and take a longer-term view on which currencies will strengthen or weaken in the next six to eight months. Fund participation in the FX market has risen sharply in recent years and its total trading share is now around 20%. There is no doubt that with the increasing amount of money some of these investment vehicles have under management, the size and liquidity of the foreign exchange market is very appealing. While relatively small compared to other market participants, when acting together, they can have a profound effect on the currency spot movements.
Central Banks
Central banks play a significant role in the Forex market as they can influence spot price fluctuations. Central banks generally do not speculate in currencies, but they use currencies to promote acceptable trading conditions to their banking industries by affecting money supply and interest rates through open market operations or the active trading of government securities. Central banks also often attempt to restore order to volatile markets through interventions. The reasons for central bank interventions may be a result of a variety of factors: to restore stability, protect a certain price level, slow down currency movements, or to reverse a trend. An example would be the recent intervention by the Bank of Japan to push down the value of the yen. On the surface, this may disturb many traders to make their investment decisions. However, it has been proven time and again that central banks can only influence currency values for short periods. Over time, the markets adjust to the changes, creating trend formations that may be very beneficial to traders. Trend strategies may guide Forex traders to take advantage of these trends in the market.
Central banks normally keep sizeable amounts of foreign currencies on hand; hence, their influence is so great that the mere mention of central banks' interventions would violently move the market. As their investments are generally more long-term, central banks' trades are quite profitable. The major central banks include: The Federal Reserve, European Central Bank, Bank of England, Swiss National Bank, Bank of Japan, Bank of Canada, Reserve Bank of New Zealand, and Reserve bank of Australia.
FX Brokers
These participants generally act as intermediaries for other participants by obtaining the best possible prices for their clients in any given currency pair.
Interbank Forex brokers usually profit by charging their clients a small commission on every trade. Retail Forex brokers tend to either charge a commission on the number of lots (contracts) traded or in the price spread by lowering the bid or raising the offer side of the market.
Individual Investors
Speculators can be anyone participating in the Forex market with the intention of making a profit from directional price movements. These Forex traders might include hedge funds, individual (retail) Forex traders, small banks and other participants trading currencies for profit.
High net worth individuals have been able to speculate in the Forex market trading in amounts of more than $1 million via banks or using currency futures for years.
Nevertheless, the relatively recent rise of retail Forex trading via online Forex brokers has enabled access to the market for speculators dealing in much smaller minimum transaction sizes or lots. Many brokers currently offer lot sizes that vary from $100,000 for standard lots, $10,000 for mini lots and down to only $1,000 for micro lots.
Retail spot currency trading is the new frontier of the trading world. Up until 1996, foreign exchange trading was only available to large banks, institutions, and extremely high net worth individuals. Prior to online retail FX dealers, individuals could not realistically participate in the FX market from a speculative standpoint. The Interbank market operated as a tight circle; it acted somewhat like a specialist, as it manipulated the fates of tiers 2 and 3 to accommodate its own needs. Accordingly, individual traders looking to trade Forex could not find a market maker capable of providing competitive spreads, fair quotes, and equitable customer service.
With the advancement of technology, the Internet, and online trading platforms, retail clients are provided with access to trading that is highly comparable to the offerings of the Interbank market. Spreads are slightly wider on most currency pairs, as opposed to the Interbank standard, but execution is unsurpassed. Now retail clients and multinational institutions can participate in the Forex market on a highly equitable and transparent playing field.
International Monetary Fund
The International Monetary Fund (IMF) is a cooperative organization that 182 countries have voluntarily joined. It exerts an international influence over world monetary issues, including the foreign exchange market. However, it has no effective authority, either by law or implied, over the domestic policies of its members.The International Monetary Fund aims to:
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Promote international cooperation by providing the means for members to consult and collaborate on international issues.
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Facilitate growth of international trade and thus contribute to high levels of employment and real income among member nations.
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Promote stability of exchange rates and orderly exchange agreements, while discouraging competitive currency depreciation.
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Foster a multilateral system of international payments and seek the elimination of exchange restrictions that hinder the growth of world trade.
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Make financial resources available to members, on a temporary basis with adequate safeguards, to permit them to correct payment imbalances without resorting to measures and destructive to national/international prosperity.