How The Global Currency Market Really Works
A Look Inside the Origins and Nature of the Foreign Currency Interbank Market
Whenever people talk about the forex or currency market, they are really referring to the interbank market, which is where really large amounts of money are exchanged. This is where all the real action takes place, and the minimum trading size to participate in this trading environment is 1 million units of base currency in a pair (for example, $1 million if you were trading USD/CAD or 1 million pounds if you were trading GBP/USD).
It is not uncommon to see daily currency trades on this market as big as $250 million or more, and the prices that the individual trader (you) sees on his/her trading platform correspond to those that the banks are currently trading. This aspect is what makes forex trading lucrative for the individual investor, because they are able to participate and trade without affecting market prices in any significant way.
Today this market exists as a highly interconnected worldwide network of secure bank computers, but it was not always this way. In fact, this market itself was born out of the need to facilitate business and commerce between countries. Large international banks an financial institutions stepped up to fill the need of large amounts of currency exchanges, and over time it grew into a bank-to-bank (hence interbank) market and became much more speculative. In fact, the 2007 Triennial Report by the Bank of International Settlements reported that there was an increase in daily forex trading volume to the level of $3.2 trillion (that's trillion with a T, as in $3,200 billion), which is a 71% increase since 2004.
As opposed to a central exchange market like the NASDAQ, this forex interbank market where the majority of trading volume occurs exists as an over-the-counter market, meaning that each transaction is a simple agreement between two parties with no regulatory oversight. Much of the trading activity is facilitated by electronic matching services that will allow banks to post bids and offers into the market.
A handful of financial firms are responsible for much of the global forex trading volume, such as Citibank, JPMorgan, Goldman Sachs, UBS, and Barclays. Other international businesses, called financial transactors, account for about 10% of forex trading volume and these are the guys that trade for business purposes or to offset exchange rate risk.
All in all, this market is so huge that no single party is able to manipulate exchange rates in a significant manner. This presents a great opportunity for individual forex traders; since they cannot affect prices in any manner, it is much like sitting on the sidelines of the global economy and simply observing the modus operandi of the big banks and financial institutions so that they can better understand what it takes to trade profitably.
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