Forex Market Structure

Forex Market & Its Structure

For us to have a baseline data  for the Forex Market, let us first analyze the market that is common to everyone market player or trader: the stock market. The infographic below shows the structure of stock market. This is how stock market’s structure looks like:

Centralized Market

Centralized Market

It is the nature of stock market to be very monopolistic. That is, one entity and one specialist. This entity solely controls the prices. On the other hand, all trades must pass and go through this specialist. Due to this monopolistic nature, prices can easily be manipulated an altered to benefit the specialist, and not the traders.

How does this happen?

Specialist in the stock market is always forced to fulfill the order of its clients. If the number of sellers exceed the number of buyers, then the specialist which is primarily forced to fulfill the order of its clients, the sellers in this case, is left with a cluster of stocks that he cannot sell-off to the side of the buyer.

To prevent this kind of things from happening, widening the spread or increasing the transaction cost to prevent sellers from entering the market must be practiced by the specialist. In other words, the specialists can simply manipulate the quotes their offering to accommodate the needs.

Trading Spot FX is Decentralized

When trading futures or stocks, it is expected for every trader to go through a centralized exchanged with just one price just like the New York Stock Exchange. This is not the case when trading in a forex market. In the forex market, there is no single price. Take a look at the infographic below to see how a decentralized market works.

Decentralized Market

Forex Market Trading

When you are in a decentralized market, then you have a lot of options to choose from. ! That’s how cool a Forex Market is.

The illustration above seems very complicated and overwhelming, but that is what makes the forex market very advantageous and beneficial. Always remember that the forex market is a huge market. If it’s a huge one, then expect to have more dealers competing with each other. The higher the competition is, the better deals will surely arise. This will allow you to choose the best deal almost every single moment. I bet you like it, isn’t it?

One of the awesome things you can do when trading forex is that, you can do it anywhere. It’s like buying a computer online. You get to choose among stores. One store may offer $2000 computer with 1 year warranty while the other stores offer same computer with the same price but with different year of warranty plus additional freebies.

The Forex Market Ladder

In spite being a decentralized market, forex market is not pure and may express chaos. In order for us to understand this better, I have created this very neat illustration. The participants can be organized into a ladder.

Forex Market Hierarchy

Interbank Market is located at the very top of the forex market ladder. Most of the participants of the forex market include the largest banks of the world and some smaller banks. They trade directly with each other or electronically through the innovative Electronic Brokering Services or through the Reuters Dealing 3000-Spot Matching.

The EBS or Electronic Brokering Services and Reuters Dealing 3000-Spot Matching compete with each other. The competition is similar to that of the most famous companies, Coke and Pepsi or Samsung and Apple. These companies are in constant competition for clients and continually try to one-up each other for market share. Both companies offer most currency pairs. However, it is not uncommon for some currency pairs to be more liquid from one than the other.

When we talk about the Electronic Brokering Services platform, EUR/USD, USD/JPY, EUR/JPY, EUR/CHF, and USD/CHF are more liquid. On the other hand, GBP/USD, EUR/GBP, USD/CAD, AUD/USD, and NZD/USD are more liquid for the Reuters Dealing 3000-Spot Matching platform.

Now who can see these currency rates? The answer is, all.

All the banks that comprise the interbank market can see the rates that each other is offering, but not all of them can make deals at those prices.

Established Credit relationship between the trading parties is still the basis for these rates. In other words, you can get higher and better rates if you have a good credit standing, just like credit card companies and banks.

After the medium sized and small banks, next in line are the hedge funds, corporations, retail market makers, and retail ECNs. These entities have to do their transactions via commercial banks. This is because they do not have constricted or closed relationships with the participants of the interbank market. With this kind of ruling, medium sized and small banks, next in line are the hedge funds, corporations, retail market makers, and retail ECN have higher and more expensive rates compared to those who are part of the interbank market.

The last but not the least are the retail traders. They are located at the very bottom of the ladder. In the past, participating in the forex market was very difficult most especially for many individuals belonging to lower and middle earner. However, that difficulties changed significantly with the advent of the internet, electronic trading, and retail brokers. Those difficult barriers to entry in forex market trading have all been taken down. With these development, entering and joining in forex market trading becomes easier and more rewarding.

Knowing the forex market structure gives you an idea on how the forex market trading works.   Now that you have already learned and understood the forex market structure, it’s time to know the forex market players or traders.

Proceed to the Next Lesson: Market Players



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