The Breakdown of the Forex Food Chain
Understanding The Different Players That Make Up The Currency Market
When it comes to the hierarchy or food chain that makes up the foreign exchange markets, it helps to understand which traders are at which levels so that you can understand where you presently fit in, and maybe work on climbing a little bit higher so that you can make some more money. I am going to use the ocean as a metaphorical parallel, so that you can better understand where you fit into this money market food chain.
A significant portion of daily foreign exchange trading volume is due to large multinational corporations that need to exchange large amounts of a country's local currency in order to do business in that country. These large companies and corporations are not too concerned with exchange rate values since they are not participating in a speculative nature. These corporations are alot like the big whales in the ocean, since they are not out to eat many of the other fish and simply spend their lives gliding along on the sidelines, and are only concerned with their own personal safety by sometimes hedging against exchange rate risk. (Yet they are really big an take up alot of space! Large multinational corporations can place orders for tens of billions of units of a local currency or more, unknowingly causing large market movements.)
The large institutional speculative forex traders that create a large portion of market movements, such as big banks and global financial institutions, hedge funds, and large investment funds are the sharks and other predators out in the ocean. They have a 'kill or be killed' mentality, and will often eat the smaller fish (which you will learn about in a minute) as well as fight amongst each other.
When big banks and investment funds are trading, they are often trying to gain the upper hand against each other and against the other smaller traders so that they can make as much money as possible. The will do whatever the possibly can to get an edge, such as paying thousands of dollars per month for a super-fast newsfeed service, since forex trading is a zero-sum environment (meaning that for every winning trade, there must be another party that has a losing trade of the same size).
Smaller individual forex traders are the trout and salmon, the tiny fish that go along living their lives eating little scraps of food (tiny profitable trades) until they get eaten by a bigger predator fish. The sharks are able to eat the smaller traders because they have lots of money that allows them to get the most powerful trading tools that give them an edge, and the smaller traders are often unable to compete and will lose money to the institutional traders.
If you are reading this then there is a good chance that you are a small individual forex trader, and you might be wondering right now if there is any way that you can move up in the forex food chain so that you are no longer the dinner of the big banks and hedge funds! Yes you can, and the answer is to stop acting like a salmon and start acting more like a whale. This means that instead of actively trying to predict where the market is going to go, even though the larger traders with their more advanced tools are going to be a few steps ahead of you, you need to step back and simply watch on the sidelines.
Being an individual forex trader, you actually have an advantage because the trading volume of the foreign exchange market is just so huge that it is literally impossible for you to affect market prices with your meager $100,000 trades. For this reason, it is the institutional investors alone that will cause most of the market movements, and your job if you wish to move up the food chain is to take a step back and observe from the sidelines.
You need to stop thinking about how you can 'beat the market' or the other traders, and instead simply watch the market movements. Now, your sole job will be to identify trends that the larger traders create, since identifying a trend is much easier than trying to beat the market. When you can identify trends and trade in the direction of those trends, you are no longer trying to predict the market as much as you are simply 'riding the waves' that the other larger traders create with their market activity.
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