The Foreign Exchange, Forex or FX Market is a global decentralized or over-the-counter (OTC) market for the trading of one currency with another. In another word, FX trading involves converting one foreign currency to another foreign currency over-the-counter or with the aid of the inter-bank network exchange from any location in the world as a matter of a network of computers linked together via the internet. This market determines the foreign exchange rates for every currency digitally. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume and liquidity, it is by far the largest and most liquid market in the world, followed by the stock market. According to BIS’s 2019 triennial survey, trading in FX markets reached an incredible $6.6trillion in April 2019, approximately $7trillion per day.
Participants And Structure Of The Forex Market
Participants In The Market
Contrary to regulated stock markets that trade in shares of public companies, the forex market is not centralized – the most important participants at the top, with trades cascading down. The largest participants have the best terms and can move the market with their trades. Because the market is so big, it is still hard for any entity to manipulate it. The forex industry works in order of size from the top down.
- Central Banks
The central banks are national banks. They are responsible for issuing and lending the national currency. Also, they are at the top of the trading activity.
Furthermore, the central banks are the ones setting monetary policy like interest rates and increase or reduce the supply of their currency. Also, they have massive reserves of other currencies and stores of value like gold bullion.
And this indicates that they hold several powers that can dramatically move the market in their currency when exercised.
For the central banks, it is way easier for them to devalue their currency than to maintain or increase a value. Also, they have a role in lending and giving liquidity to the largest banks that serve their nations.
When these large banks face trouble, the central bank must intervene to clean up any mess.
- Commercial Banks
Most of the time, people trade market volume in the interbank market – between banks. Banks trade for themselves and their clients. Then, the ‘big four’ (Citibank at 12%, JP Morgan and HSBC at 8.8%, and Deutsche Bank at 7.9%) dominates the interbank market.
For themselves, they trade as a speculative venture (but the size of this business is decreasing) and establish their inventory of currency and be a dealer to huge, professional market participants.
As dealers, banks profit from the bid or ask spreads they implement on exchange rates quoted to their clients.
- Investment Managers and Hedge Funds
The most significant customers of the banks are speculative hedge funds and managers of other investment vehicles.
They might want to exchange currencies for financing purchases of securities denominated in currencies that they do not own, hedge against risk in possible fluctuations in currency exchange rates, which could severely affect their portfolios of securities, or to speculate upon such fluctuations for profit.
As hedge funds trade in an enormous volume and gain much publicity, the pension fund industry accounts for a bigger total of assets under management.
But while their trading style tends to be more conservative, hedge funds are more significant risk-takers that typically become an immense influence upon the forex market.
- Corporations
Similar to investment managers and hedge funds, corporations deal with banks. More giant corporations often deal with the larger banks directly.
Then, smaller businesses will work with smaller banks. Forex brokers are corporations and belong in this niche in the chain of dealing. Plenty of corporations are multinational or at least interested in international trade.
And even if they do not, their profits are open to the risk of fluctuations in currency exchange rates.
- Retail Traders
Unfortunately, this is the very bottom of the trading activity – trading on worse terms compared to any other listed above. Also, they need retail forex brokerages to trade. And these brokers might not be hedging their risk on their trades.
If they are, they will often use a bank for their forex dealing. In turn, it will use another bank, which might finally have behind it one of the ‘big four’ or tier 1 banks.
For each level, the prices, spreads, and others will gradually worsen.
Structure Of The Market
The forex market is made up of two levels; the interbank market and the over-the-counter (OTC) market. The interbank market is where large banks trade currencies for purposes such as hedging, balance sheet adjustments, and on behalf of clients. The OTC market is where individuals trade through online platforms and brokers.
Currencies Traded In The Forex Market
The major currencies which account for the most pronounced volume of the total transactions in the forex market are; US Dollar (USD), Euro (EUR), Japanese Yen (JPY), Swiss Franc (CHF), and British Pound (GBP), respectively.
However, the foreign exchange market activity is the complex of transactions executed by market participants to convert one foreign currency into another currency at a predetermined rate. This is why a necessary attribute of any foreign exchange transaction is a currency pair.
The Examples Of Currency Pair: EURUSD, USDJPY, USDCHF, GBPUSD, and more.
What is a Trend?
A trend in foreign exchange trading is the overall direction of a currency or an asset’s price. In technical analysis, trends are identified by price action that highlight when the price is making higher highs and higher lows for an uptrend, or lower lows and lower highs for a downtrend.
Types Of Market Trends
In accordance with the basics of the Dow Theory, it seems reasonable to consider that there are only 3 types of market trend in forex trading, considerably to be; up, down or sideways trend. It is considered that prices may rise or fall, but actually most of the time they do move in narrow ranges.
Traders can identify a trend using various forms of technical analysis, including trendlines, price action, and technical indicators. For example, a trendline might show the direction of a trend while the relative strength index (RSI) is designed to show the strength of a trend at a given point in time.
An uptrend is marked by an overall increase in price. Nothing moves straight up for long, so there will always be oscillations, but the overall direction needs to be higher in order for it to be considered an uptrend. Recent swing lows should be above prior swing lows, and the same goes for swing highs. Once this structure starts to breakdown, the uptrend could be losing steam or reversing into a downtrend. Downtrends are composed of lower swing lows and lower swing highs.
While the trend is up, traders may assume it will continue until there is evidence that points to the contrary. Such evidence could include lower swing lows or highs, the price breaking below a trendline, or technical indicators turning bearish. While the trend is up traders focus on buying, attempting to profit from a continued price rise.
When the trend turns down, traders focus more on selling or shorting, attempting to minimize losses or profit from the price decline. Most (not all) downtrends do reverse at some point, so as the price continues to decline more traders begin to see the price as a bargain and step in to buy. This could lead to the emergence of an uptrend again.
Trends may also be used by investors focused on fundamental analysis. This form of analysis looks at changes in revenue, earnings, or other business or economic metrics. For example, fundamental analysts may look for trends in earnings per share and revenue growth. If earnings have grown for the past four quarters, this represents a positive trend. However, if earnings have declined for the past four quarters, it represents a negative trend.
The lack of a trend—that is, a period of time where there is little overall upward or downward progress—is called a range or trendless period.
Using Trendlines
A common way to identify trends is using trendlines, which connect a series of highs (downtrend) or lows (uptrend). Uptrends connect a series of higher lows, creating a support level for future price movements. Downtrends connect a series of lower highs, creating a resistance level for future price movements. In addition to support and resistance, these trendlines show the overall direction of the trend.
While trendlines do a good job of showing overall direction, they will often need to be redrawn. For example, during an uptrend, the price may fall below the trendline, yet this doesn’t necessarily mean the trend is over. The price may move below the trendline and then continue rising. In such an event, the trendline may need to be redrawn to reflect the new price action.
Trendlines should not be relied on exclusively to determine the trend. Most professionals also tend to look at price action and other technical indicators to help determine if a trend is ending or not. In the example above, a drop below the trendline isn’t necessarily a sell signal, but if the price also drops below a prior swing low and/or technical indicators are turning bearish, then it might be…to be continued!
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