The Forex market is an international Over-The-Counter Market (OTC). This means that it is a self-regulated market without a central exchange or meeting place. Unlike stocks and futures markets, where you have The New York Stock Exchange- a physical location where traders can track, buy and sell stocks. The Forex structure eliminates fees for exchange and clearing, thereby reducing transaction costs.
The Forex OTC market is formed by multiple participants – all with different needs and interests – that trade directly with each other. These participants can be divided in two groups: the Interbank Market and the Retail Market.
The Interbank Market:
The Interbank Market coordinates all Forex transactions that occur between central banks, commercial banks and financial institutions.
- Central Banks – National central banks (such as the US Fed and the ECB) play an important role in the Forex market. As principal monetary authority, their role consists in achieving price stability and economic growth. To do so, they regulate the entire money supply in the economy by setting interest rates and reserve requirements. They also manage the country’s foreign exchange reserves that they can use in order to influence market conditions and exchange rates.
- Commercial Banks – Commercial banks (such as Deutsche Bank and Barclays) provide liquidity to the Forex market due to the trading volume they handle every day. Some of this trading represents foreign currency conversions on behalf of customers’ needs while some is carried out by the banks’ proprietary trading desk for speculative purpose.
- Financial Institutions – Financial institutions such as money managers, investment funds, pension funds and brokerage companies trade foreign currencies as part of their obligations to seek the best investment opportunities for their clients. For example, a manager of an international equity portfolio will have to engage in currency trading in order to buy and sell foreign stocks.
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