Who Trades Forex
Central banks & Governments:
Central banks form an integral part of the economy and work in coherence with government policies. The central banking authority is responsible for determining the course of the country's monetary policy. That in itself is the major factor determining the value of the foreign currency of each country. The central bank’s objectives are traditionally mandated by governments and are usually tied to inflation and employment.
In the earlier days of central banking, the common choice for central bank reserves was Gold. After US President Richard Nixon scrapped the gold standard in 1971, in the last 50 years, the monetary unit for reserves has been replaced by the U.S. Dollar. It is considered the international benchmark currency for any trade settlement and on the foreign exchange market. Apart from the US dollar, central banks also hold reserves in Euros (EUR), Swiss francs (CHF), Japanese Yen (Yen), and British pounds (GBP) among other currencies.
These reserves are sometimes used to stabilize the domestic currency or manipulate it towards the desired level by the central bank of a country. Such intervention can lead to a rise or fall in demand for the domestic currency in the market, thus impacting inflation. Sometimes, a verbal intervention is taken as a preferred measure to trigger currency movements under certain circumstances.
Meanwhile, apart from the power of printing currency and having a strong role in the country’s financial health, any comments by central bank policymakers should be monitored closely as they can have significant effects on a country's currency.
Commercial and investment banks
Apart from central banks and governmental authorities, commercial banks also play a significant role in trading forex. Although their scope and reach are vast and broader than those of an individual trader, the agenda, as well as notion, is not much different – both seek to maximize their profits out of the transactions in the forex market. Irrespective of the size and scale of commercial banks, their primary motive to trade forex is not only to minimize their risks from market exposure but also to manage the portfolios of their clients. Banks trade through their dealing desks, which are focused on risk management, arbitraging, hedging, or a combination of various strategies to capture maximum benefits.
Among the active traders in the forex market, there are about 25 such banks, namely Deutsche Bank, UBS, RBS, HSBC, Merrill Lynch, Barclays, JP Morgan Chase, and smaller players such as ABN Amro and Morgan Stanley. A wide array of deals are quoted every instant, with the standard deal size being USD$5-10 million, with the total size of tickets reaching as high as USD$100-500 million. These trades are made via an electronic terminal connecting to the counterparty or through phone calls.
What differentiates banks from non-banking financial organizations in this regard, is the unique access of the former in their clients’ buying and selling intentions. The precious 'insider' information helps banks have an upper-hand in dealing with clients. Nevertheless, no financial institution – banks or non-banking financial corporations are greater than the market, and any volatility event makes them respond by adjusting their positions.
Businesses & Corporations
The third group of traders are businesses and corporations that deal with imports and exports. This is a large group of market players and consists of small to multi-national firms that all participate in the currency market, to address their business needs.
The strategies that they undertake can affect markets to a certain extent and is usually related to the future value of the goods they are moving. In order to hedge their risks, such companies are employing FX strategies that minimize their exposure to uncertainty and volatility across the currency markets. Like other big market players, their active participation in the FX market has an impact on the price-formation of forex rates.
This category of market participants takes advantage of the fluctuations in exchange-rate levels rather than hedging their Foreign exchange risk. They usually trade in significant size, and therefore, a minor difference in the exchange rate can yield them millions of dollars in profits or losses.
Hedge funds are the most controversial class of speculators, which are often engaged in using riskier and sometimes market unstable strategies to make large returns. Given this position, they can have a major impact on any country’s forex market. The Asian currency crisis of the late 90s has been blamed by many on the actions of a variety of hedge funds, while others pointed towards the central bankers of the time. No matter which it is, speculators can have a major impact on any the currency of any country under certain circumstances.