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Structure of the Forex Markets

The foreign exchange market – also referred to as FX and mostly as Forex – is by far the largest and most liquid market in the world. With an average turnover of over 6.6 trillion USD in daily trading volume, it’s where traders go to speculate on and exchange national currencies.

Although the size of the Forex market is overwhelming, the mechanics of trading Forex are less noticeable.

There’s a general understanding of how the stock market works, but the Forex market is more enigmatic. Where is it located? How does it work? What are its building blocks?

The answers to these questions are rooted in understanding the Forex market’s basic structure and key players.

A global, online market

Stock trading is built on centralised exchanges like the New York Stock Exchange. There are physical locations for those exchanges and tangible entities. Because the market is centralised, all trades go through that entity, and that entity controls the price.

Things are different with the Forex market. Firstly, there isn’t a singular entity governing it, and the price of a currency is affected by the movement of other currencies and not by the decision of an entity.

Second, it’s traded electronically using over-the-counter platforms and computer networks. In most cases, automated straight-through processing (STP) finds the best price on the market at any given time. So, traders aren’t buying physical money from an actual physical location.

The key players

To get a deeper understanding of how this decentralised structure of the market works, let’s take a closer look at its key participants.

Market operators (the interbank)

This group includes governments, central banks, and the world’s largest banks, including Bank of America, Deutsche Bank, Citi, HSBC, Barclays, JPMorgan, UBS, and Goldman Sachs. These market operators don’t mess around. They trade with large amounts of money, typically no less than 100,000 USD, and make a massive amount of Forex transactions every day. Because they do, they largely determine the Forex market’s exchange rates based on the supply and demand of the traded currencies.

Market makers

Market makers are large financial firms that provide trading opportunities for brokerage firms and individual traders. Market makers don’t always offer retail traders access, but they do provide liquidity to brokers. Some provide access to traders, but with fixed pricing and a mark-up, which acts as their fee, hence why Market Maker prices can be pricier and suit a specific type of traders. Because of the amount of trading they do, they are responsible for currency conversions that also affect Forex prices.

Retail traders

Retail traders access the Forex market by opening an account with a brokerage firm that offers everyone an opportunity to trade with small amounts and leverage. Traders access the market on user-friendly platforms that simplify the process for traders, like MT4. The way traders can potentially make money is through the difference between foreign exchange rates. While every retail trader individually may not significantly affect the market traders’ overall speculation and movements do. For example, when a noticeably large number of traders sell a currency simultaneously, it can affect that currency’s price. The Forex market may not have a central, physical entity that determines the prices. Still, its valuations are based on actual transactions, supply and demand are determined by millions of market participants.

And there you have it! The combined activity of all players in the Forex market, from the most prominent institutions to retail traders, make this market the biggest one.