Forex traders and investors are a diverse group, coming from a broad spectrum of backgrounds, ages and disciplines. From the individual who is brand-new to the market, to the most seasoned currency trader, engaging in forex is one of the most common methods of participating in the world's financial markets.
Considering the low entry barriers, seemingly all one needs to begin trading forex is a computer, internet connection and brokerage account. While each person enters the marketplace with a unique set of goals and objectives, forex traders are typically divided into two major categories: institutional and retail.
Institutional Forex Participants
The largest players in the forex market are institutions, or institutional traders, and investors. Institutional money accounts for the majority of forex trading, estimated to be approximately 94.5% of the market volume. While the term "institutional" is often used as a catch-all for larger market participants, there is a difference between "institutions" and "institutional investors":
- Institutions: Physical entities that engage in the direct buying and selling of currencies on behalf of their own accounts to hedge against systemic exposure. Examples include official central banks and commercial banks.
- Institutional Investors: An individual who enters the market on behalf of another party, entity or fund. For example: the world's largest pension fund, Japan's Government Pension Investment Fund (GPIF), commissions a number of private-equity managers to invest its portfolio of assets.
The behaviour of institutional participants within the forex sector often dictates the market state. By far, the volumes created by the trading operations of institutions and institutional investors are capable of enhancing periodic volatilities and driving markets directionally.
Retail Forex Participants
The second classification of forex market participants is known as "retail." In contrast to institutional money, retail traders and investors trade for their own private account, risking their own capital.
While the forex volume generated by retail traders is nowhere near that of institutional participants, they are present in large numbers. For example, leading forex brokerage service FXCM provides market access to 130,000 separate customer accounts, totaling US$3.5 trillion in retail trading volume for 2016.
Retail participants come in all shapes and sizes, but typically trade on forex in two fashions:
- Short- and Intermediate-Term Trading: Strategies such as scalping, day trading and swing trading are common practices among retail traders.
- Long-Term Investing: While not as common as short-time frame trading, long-term investment strategies are implemented by individuals aspiring to profit from trends in currency valuations. Traditional safe-haven assets like the British pound sterling and Swiss franc are often targets for retail investors interested in asset preservation.
Forex: The Key Players
While each forex trader or investor is either institutional or retail by designation, there are several key players that influence liquidity, volatility and overall market state.
The following are members of the forex community that can have an extensive influence on the entirety of the international currency market:
- Commercial Banks: Banks come in assorted varieties, ranging from local credit unions to international investment banks. A large part of a bank's core business is lending hard currency and balancing assets with liabilities. In order to preserve solvency, banks trade currencies amongst themselves on the interbank market, in conjunction with the larger forex market. Interbank lending constitutes much of the global currency trade, and is used to limit risk exposure.
- Central Banks: A nation's central bank is commissioned with establishing the monetary policy of the domestic economy. Central banks set interest rates upon the local currency and directly influence the money supply of a nation. Through these two functions, central banks play an integral role of exchange rate valuations of forex.
- Hedge Funds: As large pools of capital that are allocated to investment practices, hedge funds commonly take positions in the international currency market, as a means of both balancing risk and achieving capital appreciation. Pensions and private equity funds are two examples of hedge funds.
- Corporations: Companies involved in foreign trade often engage the currency markets as a means of supplementing value lost due to exchange rate disequilibrium. In the event of an appreciating domestic currency, a company's ability to profit from the delivery of goods and services abroad may suffer. Taking an offsetting position in the currency market is one way of supplementing value to business operations.
- Individuals: The largest number of forex participants, individuals, are actually responsible for only a fraction of the overall traded volume. Individuals trade their own money in an attempt to profit from the market, just like a sole proprietor conducts regular business. While relatively small in terms of market share, individuals contribute to the overall sentiment and liquidity of the forex.
Whether one is a small retail trader attempting to sustain profit in the marketplace, or a large institution looking to hedge out systemic risk, it is a good idea to be aware of the important characters in the forex market. Through understanding the players and the motivations behind their market positioning, potential opportunity may be identified, while mitigating undue risk.
As the world's largest marketplace, averaging over £5 trillion in daily turnover, the forex market is a premier financial venue. Millions of individuals around the globe manage risk, speculate on exchange rate fluctuations and attempt to secure profit from actively engaging in forex.
No matter if one is trading retail or is part of an institutional framework, entering the forex market may potentially be a viable way of capitalising on opportunity within the marketplace. Having a considerate trading strategy, adequate risk capital and a working knowledge of the landscape could be helpful when entering the growing ranks of forex market participants.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. Friedberg Direct will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…