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Of all the markets in the world, forex has the bragging rights as the largest global financial market. In fact, the daily volume in the FX trading exceeds $6 trillion, a daily volume that goes beyond even the stock market.
But who are the big players that can afford to pass around that amount of cash? Why would they want to participate in trading real-time forex pairs?
To understand why so much money passes through the foreign exchange market, you must first understand what it is.
There are many reasons why people participate in the forex market, but they largely boil down to two specific reasons — hedging and speculation.
Oftentimes, hedging in the forex market is done by companies and small businesses that are at risk of fluctuating currency values when they conduct business in foreign countries. For these companies and businesses, getting involved in the forex markets means they can fix a rate to complete their transaction, thus hedging their currency risk.
They can fix a rate by buying or selling currencies in advance. For example, consider a company that sells a product manufactured in the U.S. with plans to be sold in Europe. The exchange rate for this transaction would be between the Euro and the USD or EUR/USD.
Let’s assume at the time of the deal, the Euro and USD were at a €1 to $1 parity. However, when it came time to sell, the value of the USD rose, bringing the EUR/USD exchange rate to $0.70. That would mean that even if the company sold its product for €200, the exchange rate would have caused a dramatic $60 difference in profit per product sold.
To avoid this significant profit loss, the U.S. company could reduce its risk by short-selling the EUR/USD currency pair when it was trading at parity or €1 to $1. That means, if the USD rose in value, as it did in this example, then the profits from the short-sell would offset the reduced profit from the exchange rate at the point of sale.
On the other hand, if the USD rose in value instead, then the product would have sold at a higher profit due to the difference in the exchange rate, which would have then offset the losses from the trade. These types of trades are generally conducted in the currency futures market.
Speculative trading, on the other hand, takes a more fundamental and technical analysis approach. It factors in information such as interest rates, Central Bank predictions, economic strength, geopolitical risk, and supply and demand, to name a few when deciding when to buy or sell.
Those involved in purely speculative forex trading search for opportunities to profit from changes in one currency’s value compared to another. Speculators will have a bias based on their fundamental or technical analysis that will trade a currency they think is strongest versus a currency they feel is the weakest to capture the largest movement.
The largest players in FX trading are institutional traders or institutions. You could say that most of the money that makes up the market data in FX trading comes from institutional money.
It’s the actions and the market anticipation of these institutional investors and institutions that often determine the state of each currency pair. The money from these entities is capable of determining an impulsive directional move and creating volatility. However, there is a difference between an institutional investor and an institution.
An institutional investor is a person, typically working in financial services, that participates in buying and selling various currencies on behalf of another entity, party, or fund. For example, private equity managers of a pension fund are considered institutional investors that participate in the forex market on behalf of the fund.
Institutions, on the other hand, are the actual physical entities that directly engage in the forex markets on behalf of their personal accounts. Oftentimes, their involvement is for hedging purposes. These institutions include central banks like the Federal Reserve and other large commercial banks.
The rest of the market participants are known as retail traders or retail investors. In contrast to institutions and institutional investors, retail traders and investors trade their own personal accounts and risk their personal capital.
And although the volume generated by retail traders is nowhere near the amount from institutions, it is still a significant sum. Retail traders typically participate in the forex market to generate a profit in one of two ways — day trading, swing trading, or long-term investing.
The sum up, the key participants in forex trading, include:
Commercial banks include most financial service companies from small local credit unions all the way to behemoth international investment banks. Generally, a large part of any commercial bank’s business is to lend currency and balance its assets. In order to maintain solvency and limit risk exposure, banks will trade with each other on the interbank market and the global forex market.
The interbank market is essentially a global network that institutions use to trade currencies between themselves. Most times, interbank trading involves their bank’s own accounts, although some interbank trading is conducted on behalf of large customers or “whales.” Most of the trades conducted on the interbank market are short and generally overnight transactions but can be up to six months.
The second key player is the global central banks. A country’s central bank, like the Federal Reserve, is tasked with the responsibility for the country’s domestic economy and monetary policy. Their decisions on interest rates have an effect on the money supply and, ultimately, the value of their country’s currency.
Hedge funds act as large pools of capital that participate in most financial markets, the global currency market included, to balance risk and appreciate their allocated capital.
As stated earlier, corporations and small businesses typically get involved in the forex market as means of hedging. Getting involved in the foreign exchange market to offset a position is one way a business or corporation adds supplemental value to its operations.
Lastly, there are the individual investors or retail investors that comprise a fraction of the daily traded volume in the forex market. These traders risk their own money using their preferred trading platform and broker in a speculative attempt to profit from the market.
At the end of the day, there are many reasons why an individual or institution would get involved in the forex market. Clearly, with a daily volume of over $6 trillion dollars, it’s a market that’s here to stay and a market that can see an account surge in profit and a loss.
Regardless of whether you’re a retail trader or an institutional investor, getting involved in the forex market is a viable way to capitalize on an opportunity with a literal ton of money flowing through.
Are you ready to jump into the wild world of forex trading? Get started with a risk-free demo or live account today!
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