Forex Market Traders and Their Purposes
The forex market is the largest financial market. And many forex market participants use the currency markets to hedge against international currency and interest rate risks. The following are the major market players in the forex market and their corresponding purposes.
Commercial and Investment Banks
The interbank market is where the largest volume of currency trades happens. Banks of all sizes trade currencies with each other via electronic networks.
Huge commercial and investment banks account for a large percentage of total currency volume trades. Banks facilitate forex-related transactions for their clients. They also conduct speculative trades using their own trading desks.
When banks serve as dealers for their clients, their profits are the bid-ask spread between the two currencies in a pair. To profit from currency fluctuations, speculative trades take place.
Countries’ Central Banks
Central banks generally represent their nation’s government. They are extremely important players in the forex market.
For instance, open market operations and interest rate policies of central banks influence currency rates to a huge extend.
The central bank is responsible for fixing the price of its native currency on forex. Their exchange rate regime will influence how the currency will trade in the open market. Exchange rate regimes are of three general types: fixed, floating, or pegged.
Any action that the central bank takes in the forex market is aimed at stabilizing or increasing the competitiveness of the nation’s economy.
Central banks may also engage in currency interventions to make their currencies go up or down. Also, central banks use strategies to control inflation. Thus, their decisions and plans serve as long-term indicators for currency traders.
Hedge Funds and Investment Managers
Portfolio managers, pooled funds, and hedge funds account for the second-largest collection of players in the forex market after banks and central banks.
Investment managers trade in the forex market for large accounts like pension funds, endowments, and foundations.
For instance, an investment manager holding an international portfolio may have to buy and sell currencies to trade foreign securities.
Investment managers may also create speculative forex trades. Some hedge funds execute speculative currency trades as part of their investment strategies.
Corporations and Multinationals
Firms that are in the import and export business also conduct forex transactions in order to pay for goods and services.
For instance, a German producer that imports American components and sells finished products in China must exchange euros for dollars to buy more American components.
Companies that trade forex are doing so because they want to hedge the risk related to the foreign currency conversions. The same German producer can purchase American dollars in the spot market, or enter into a currency swap agreement to obtain dollar before it buys the components from the American company.
Retail investors and the amount of trade volume they account for in the forex market are extremely low when compared to the financial institutions discussed above.
On the other hand, retail trading is growing in popularity at rapid pace. Retail investors base their currency trades on a combination of fundamentals and technical variables.