Forex exchange, the biggest and most liquid market in the world attract millions of small, medium and big size participants. They have different purposes and goals and different time horizons for their currency operations. Combined, all of their orders and positions produce a multilayered market structure, which determined the daily movements of the currency pairs and reactions of the market to news events.
The forex market is an OTC (over the counter) market. That means it has no specific central market place. It is fairly distributed among all the biggest financial centers in the world. The biggest center, which is responsible for the main currencies cash flow is London. According to the Bank for International Settlements April 2010 survey, London accounts for about 37% of the daily transaction volume. The other big centers are located in USA (New York) – 18% of the transaction volume, Japan (Tokyo), Switzerland (Basel and Zürich), Singapore, Hong Kong and Australia. According to the same survey in 2010 the daily turnover in the whole forex world is about 4 trillion $. Of this number 1.5 trillion $ accounts for spot transactions and the other 2.5 trillion $ accounts for forwards, swaps, options and other forex derivatives. The US dollar is an exchange currency in 85% of all transaction, while Euro participates in only 39% of all transactions. Japanese yen, Pound Sterling, Australian dollar, Swiss franc and Canadian dollar are the other big members of the forex world. They are known as majors. All the other currencies, except the specified above participate in only about one quarter of the whole forex transaction volume.
If we want to understand this incredible market structure we have to know two things: which are the main participants and what are their main reasons to participate in the forex market. In present days about 80% of the forex market volume accounts for speculative transactions and only the remaining part of money transfers are involved in real economy. Some people claim that this is a dangerous situation, but the speculative volume, by contrast is a source of liquidity and allow narrow spreads and lower transaction costs for the real economy transactions. We could divide all the speculative market participants in the following groups, depending of their timeframe and primary goals:
(1) Currency Investors – they use the forex market for hedging of their operations, for long term trend following or use a carry trade strategy (buying high interest rate currency with a loan in a low interest rate currency for a considerable period of time). Their positions stay in the market for weeks, months and even years.
(2) Position traders – they try to catch market movements in several days or weeks time frame. Often they add to a position several times in order to improve their entry point.
(3) Daytraders – they try to exploit price movements in the time range of minutes to hours.
(4) Scalpers – they are the faster and most mobile group of forex traders. They put their money in the market for several seconds to several minutes and try to exploit the very short price movements and fluctuations. They use the biggest leverage among the market participants, but have no impact on the bigger time frame movements, because they cover their positions very quickly.
We could define different market participants also according to their size and type of institution. In the first place among the biggest participants in the forex market are the central banks. Their primary goal is to try to control the demand and supply of the particular currency by either direct buying or selling operations, known as interventions or by changing the interest rate for that currency, which could affect the incoming and outgoing money flows. Some central banks of the export-oriented economies accumulated in the recent years tremendous reserves of foreign currencies and tried to use the forex market for active management of their reserves. The typical example of such a country is Chine, with more than 2 trillion $ of reserves in their central bank.
The other group of big participants is the commercial banks. They accumulate the exchange flows from different commercial customers and also have their own speculative subdivisions (proprietary desks). The biggest participants among this group are Deutsche Bank (Germany), Barclays Capital (England), UBS (Switzerland), Citi and JPMorgan (USA). Some of them have their own market maker divisions and account for large extend in providing the market liquidity.
The next group of big market participants is the hedge funds and investment funds. They have the only purpose in their operations a speculative gain, so they account for a big part of the speculative market volume. In the category of investment funds is included the subcategory of Sovereign Funds. These are state funds, which are held by governments of some countries. The most known among them are the Abu Dhaby Investment Authority, Government Pension Fund of Norway, China Investment Corporation, Government Singapore Investment Corporation. They have medium and long term investment horizon and account for a big part of today forex transactions.
The smallest, but the most rapidly growing part of the forex world is the retail segment, which account for all the individual traders in the world. With rapid development of the technology and electronic execution of the trades and also the increased popularity of automated strategies this part will continue to grow faster than others and could probably become a significant part of the transaction volume in forex market.