Who Engages in Forex Trading and Why?

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forex education| TTS Markets

There is a peculiar humor in the paradoxical nature of the Forex Market. Albeit being the largest economic market in the world, overshadowing even the Stock Market by almost 200 times in terms of its size and earnings, very few people are aware of it.

Strike a random conversation with one of your close friends and family members and ask them what they know of the Forex Market. Chances are that they’d either have a very vague idea of the concept or absolutely none at all. 

So, if most people are unaware of it, who is actually trading in the market? In this present chapter, I will tell everything you need to know about the Foreign Exchange Market and its participants, who actually trade in it and how they make their profits.

Large Banks

Large banks are one of the key players in the Forex trading market. They are in charge of the multiple transactions that take place on a global level every day and supply the needed cash flow to enable the sizeable transactions to take place. 

All the prominent banks have an “interbank network” that permit them to stay connected with each other. This is the network that witnesses most of the Forex transactions.

The Bid and Ask prices are determined by the large banks depending on the demand and supply of the currency in question. Bank’s primary profit comes from the “Spread” which is the difference between the bid and the ask price. 

You can envision the large banks as the sharks in the ocean! They are the ones with the most amount of money. It is the bank that provides the opportunity of transacting in the Forex market to its customers. 

Smaller retail brokers are associated with a number of banks to get access to the bank’s virtually limitless cash flow. This enables the brokers to give the customers a leverage and allow them to borrow the money temporarily and utilize the bank’s sizeable resources to open long positions for trading.

Despite the larger sizes and deeper pockets of the banks, they do not engage in speculative trading for their own profit from the Forex market.

Banks are better known as the “market makers”. Instead of utilizing the resources for their own benefit, they make the cashflow accessible to the customers of the banks to help them to make trades. The primary source of income for the banks is the commission they get from this liquidity that they furnish.

Central Banks 

Besides the Large banks, the central Banks too play decisive roles in the Forex Market. The central banks hold the important responsibility of maintaining the stability of their country’s currency. 

The central banks exert an impact on the foreign exchange rate of their country’s currency through shrewd manipulation of the interest rates and the government policies or by resorting to aggressive market interventions.

The central banks hold the choice of either fixing or “pegging” the value of the currency of their country in relation to another currency such as the USD or to keep it “floating” where the valuation of the currency would fluctuate according to the demand and supply of that currency.  

In the present day, floating currencies are the most common sight, with more countries opting to leave the fate of their currencies in the hands of the Foreign Exchange market when the exchange rates vary depending on the demand and supply.

However, every once in a while, we see a country fixing its currency value to stabilize the condition of its economic market. Recently, the Swiss National bank pegged the value of Swiss Franc to 1.2 EUROS to safeguard its market from the potential collapse of the import and export industry due to the high valuation of the Swiss Franc. 

The Bank of Japan also adopted a similar technique to save its import and export sector. The bank deliberately started selling off its currency to keep the currency from gaining strength. A strong Yen would have had a disastrous impact on the import and export sector that could potentially decimate the economy of the country. Drastic measures had to be taken to salvage the country’s economy from collapsing. 

Commercial companies

Besides the large and centralized banks, commercial companies also need to engage in the Forex market to facilitate their usual business. For instance, when Walmart in America needs to export their products to India, the company needs to exchange their USD to Indian Rupee. 

Similarly, suppose an American company wants to place an order for certain parts from the Chinese market, the US dollar needs to exchanged for Chinese Yuan. This is how the commercial companies, both large and small, engage in the Forex Market and thereby cast an influence on it. 

Commercial companies are also called the “hedgers”. The hedgers adopt a peculiar Forex Trading strategy. Rather than going with the flow of the present trend of the market, it takes the opposite route. 

At a first glance, the strategy might sound counterproductive, if not self-damaging. However, the companies have a good reason to follow it. This peculiar strategy is adopted by the companies to brace themselves against a blow in case of the currency undergoes sudden fluctuations in valuation.

For instance, an Australian company might decide to initiate a short hedge trade while the Australian dollar is increasing value at a time when the company had placed an order to its manufacturing unit in China.

At the time of payment, while the company would incur a loss in actual trade due to the increased valuation of the Australian dollar, the cheaper exchange rate would help to counterbalance the loss.

Similarly, a relatively weaker Australian dollar would result in a loss during the currency exchange, however, the profits in the actual trade would help balance out the losses. This strange technique is employed by most companies to protect themselves from suffering from undesired losses when the currency exchange rates fluctuate. 

Large Speculators

Speculation is the act of investing in stocks and the Forex Markets in the hopes of obtaining a profit. When we think of the Forex market, our mind automatically darts to the speculators. 

Now, speculators are of two kinds – large and small. The difference between a large and small speculator depends on the economic standing of the two. The hedge funds, fund managers, insurance and superannuation companies primarily make up the large speculators.

The prime goal of the large companies while participating in the Forex Market is to make a profit. They are known as market speculators because they buy when there is a bullish trend in the market and open a short position when the market trend is bearish. Large speculators are known to flow in the direction of a profitable trend and are hence given the moniker of “smart money”.

Small Speculators

Retail brokers and traders like you and me are termed as the small speculators or simply the “small specs”. While the small speculators are also in the trade to make money, we have a minuscule impact on the Forex market as a whole because our investment capacity is much less compared to larger speculators and other commercial companies.

Smaller speculators are often termed derogatorily as “dumb money” due to the fact that approximately 95% of the forex traders are losing money. In fact, most amateur traders end up losing more than they profit from the Forex Market. 

Bank Manipulation Trading strategy is the most tried and tested way to make high profits at low risks. The technique has yielded profitable results throughout the years and still continues to do so. 

Besides the trading strategy adopted by the said trader, his psychological climate and the headspace that he approaches the trade with also play an integral role in his chances of success. Impulsive action or allowing one’s emotions to run rampant are some of the common forex trading mistakes made by all inefficient Forex traders.