Skip to main content

Forex Trading And Pricing Explained

I received the following question from one of my list members today:

"... you referred to the currency exchange cash market and the fact that this is basically a market between banks across countries. Does this mean that, for example, the EURO/USD exchange rate is set between the Federal Reserve and the ECB? Is that how a price is established without the benefit of any trading on any listed exchange anywhere else? Thanks for the brief education on this particular point." - Stan Z.

The forex spot market is primarily an "interbank" market. That means the majority of the trading volume is done bank-to-bank such as between Citibank and Goldman Sachs, for example. This trading is generally done on behalf of banking customers such as multinational corporations, though the banks also trade with each other both to hedge their currency exposure and to take on trading positions.

This sort of market structure is the same as the one for most cash market government debt trading, such as that for US Treasury Bonds and the like. You can think of it like the over-the-counter market for stocks. Those trades don't go through an exchange, but are done directly broker-to-broker.

In both forex and fixed income there are big players like hedge funds that take part along with the commercial and investment banks. The world's central banks are also major participants at this level in their attempts to influence exchange rates (forex) and/or interest rates (fixed income).

The transaction sizes in the interbank market are large - generally $5 million and up. Obviously, the average individual trader is not going to be trading anywhere near that big. That's where the online brokers and forex dealers come in to play. They allow small traders to do transactions in significantly lower amounts. In fact, there is at least one which will do trades as small as $1.

Here is where some folks get a bit nervous. Many of these forex dealers actually act as market makers with their clientele. By that I mean they take the other side of the trades that are done by their customers. This is something which can sometimes happen in the stock market as well, especially with OTC stocks. The concern that folks have with this is the implied conflict of interest in terms of price execution that creates. Is a dealer who will be taking the other side of your trade going to be acting in your best interest when you put on a trade?

While it may be true that some unscrupulous dealers may take advantage of their customers in that way, I am quite confident that most of them are not acting against their customers. They simply provide liquidity to the market and earn the spread to do so. When they have an excessive exposure to any particular currency, they offset it by hedging in the interbank market or with another dealer. That's basically the same as a floor trader on any exchange.

Getting to the question of how prices get set, the market does that, not the central banks. Each individual bank and dealer is actually setting its own price. That might sound a bit strange in that it would create different rates all over the place. The fact of the matter is, however, that prices between dealers and banks are almost always going to be very, very close. There are services such as Reuters where dealer prices are aggregated and presented in data feeds, allowing everyone to know the current (and historical) market rates. Arbitrage trading keeps dealers from quoting prices too far away from each other.

There is also trading in the futures market, and the relatively new currency exchange traded funds (ETFs). The activity there, while only a small fraction of the global market volume, also contributes to keeping prices in line across the board.

Popular posts from this blog

Choosing The Right Forex Software For You

You might be looking for a charting platform, or a trading platform. You could also be looking for an automated trading program, or a signal service. You are most probably looking for some form of assistance to help with your trading. This is really the holy grail for a lot of traders who do not have the time or the inclination to sit in front of a computer 16 hours a day. I have done that for a couple of years and done my 'chart-time', now its time to let the computer take care of it for me.
The best charting and trading platform is MT4, this allows you to also create custom indicators and expert advisors allowing you to auto-trade your account. Some people have created truly excellent Expert Advisors, and its like having your own forex trading guru sat at your computer 24/6, never getting tired, grumpy, hungry or anything else for that matter.
Provide a stable internet connection and power, and the EA will handle everything else for you. The problem is selecting the correct on…

Is It Safe To Invest In Shares Or The Forex

You feel yourself financially able and personally qualified to invest. You can meet the conditions of reasonable stability, reasonable flexibility, and reasonable caution. But nagging doubt remains. Wouldn't you really be better off with your extra cash in a savings account?
Or a piece of real estate? In short, is it really safe to invest?
Well, how much safety do you require? Since there are no absolutely sure things anywhere, safety must be looked at as a matter of degree. There are no guarantees of success in stock ownership, no guarantees against loss. Even the thoughtful, conscientious investor can be taken to the cleaners.
It should be remembered, however, that investment in stocks is a way of sharing in the profit potential of American industry. Is the American economy safe? It seems to be. Since 1900 it has been rising in productivity at an average rate of 4 per cent per year. Our Gross National Product is now nearly $480 billion. By 1965, according to quite conservative esti…

How To Start Forex Trading

If you're looking for a smart, new way of investing your money, look no further than FOREX! Many individuals have turned to FOREX to replace their stock activities and to supplement their
income. When done correctly, you can see a big return on your investment.
What is FOREX?
FOREX is short for foreign exchange. The best way to understand FOREX is to think of it as buying and selling money. This is done through the international foreign exchange market.
Participants of the FOREX market buy a specific currency and sell it when it is favorable to do so. Your best bet as a FOREX trader is to understand and analyze trends so you can pick up on a rising currency, whether it is the Japanese Yen, the Euro, or another currency.
Practice Makes Perfect
Because there is real money involved in FOREX trading, it is understandable that many people are hesitant to join in on the action. The good news is there are ways to practice without investing real money. You should read up on various trading tech…