Abstract:

Institutional foreign exchange is the big end of town when it comes to the FX market, but what they do as a group has a large bearing on short to medium moves in the currency markets. Knowing who they are, what they do and why they do it gives us little trading people the chance to survive

This is the big end of town when it comes to talk about the foreign exchange. Don’t forget we are talking about a more than $2 trillion a day size business; so to be ‘big’ in this business is to talk about huge amounts of funds being traded at the bat of an eye. While it is standard to trade 5-10 million dollar parcels, very often 100-500 million dollar parcels get quoted. Compare that with your likely size trading position, so you can see we are dwarfs of a market for giants. It is important too to note, that even these guys are vulnerable to market moves and are also subject to market volatility. That is, no one controls this largest of the worlds financial markets.

George Soros and his quantum fund for instance, though famous for winning in the FX market against the Bank of England in 1992, in its turn lost substantial amounts (many 100s of millions of dollars) of his hedge funds money betting against the USD/YEN exchange rate in 1995. He too was not as big as the market. The thing to remember, no one is bigger than the market – even the major global brand name banks so ‘insider’ information is not only hard to come by, but it is also quite doubtful that even if you did have the information, that it would be anything but of passing value.

The Players

Banks
Whether big or smaller scale, banks participate in the currency markets both from the point of view of managing their own foreign exchange risks and that of their clients. They also speculate should their dealer/traders have a particularly strong view of the market. What probably distinguishes them from other players is their unique access to the buying and selling interest of their clients that gives them an insight to the likely buying/selling pressures on the exchanges rates on a particular day or some such other like small timeframe.

Deals are transacted by telephone, broker (we will talk about these people later) or via electronic dealing terminal connection to their counter party. The usual transaction time is somewhere between 5 to 10 seconds, so the skills of the foreign exchange dealer demands agility of reflexes and decisiveness particularly when we are talking about transactions of multi-million dollar size transactions.

Brokers
The foreign exchange broker acts as an agent in the same way to that a stock broker acts in the share market. The slight difference being that they usually confine themselves to acting between inter-bank market participants, and do not accept orders from corporate clients. 

What the broker does from all his markets, he selects through their extensive and direct electronic bank contacts the highest bid and lowest offer and combines them to establish the best two-way price ‘the market’ can provide and displays  or verbalizes this for all to see and hear.

As if the changes in the FX broking industry were not enough, increasingly and with the unstoppable advances in technology (as evidenced by the emergence of electronic broking platforms such as EDS and Reuter dealing systems) the task of customer/order matching is being systematized and dispensing with the human element altogether.

Central Banks
The majority of developed market economies have a central bank. The role of a central bank tends to be diverse and can differ from country to country. In Australia, its central bank is the Reserve bank of Australia (i.e. the ‘RBA’, see also www.rba.gov.au) and is charged with the responsibility of maintaining an orderly market for their national currency.

In a practical sense this involves them monitoring and checking the prices dealt in the inter-bank market. Sometimes they even ‘test’ market price by actually dealing on them to check the integrity of quoted prices. In extreme circumstances where the Reserve bank feels prices are out of alignment with broad fundamental economic values, it may ‘intervene’ in the market to influence its level directly. The intervention can take the form of direct buying (to push the price up) or selling (to push the price down) or as often ‘jawboning’ by commenting in the media about its ‘preferred’ level for the currency.

Bankers, fund managers and companies all tend to respect the opinions (if not always agree) as the sheer financial power of a central bank to borrow or print money gives it a huge say in the value of a currency. Their opinions and comments should never be ignored and it is always good practice to follow their comments be it in the media or on their website and can be powerful indirect influences on the currencies value at any particular point in time. Particularly as money and currency markets are very sensitive to rates of return being offered by various markets (i.e. interest rates).

Corporations
As the name implies they represent companies and basically businesses of any size (from small to multi-billion dollar cash flow enterprises) that engage in commercial or capital transactions that require them to either purchase or sell foreign currency.

Traditionally they have been divided between those who need to buy the local currency ‘exporters’ (i.e. they have foreign currency to sell) and those who need to sell  the local currency to buy foreign currency known as ‘importers’.