Foreign exchange market (FOREX)
The foreign exchange (currency or forex or FX) market

exists wherever one currency is traded for another. It

is by far the largest financial market in the world, and

includes trading between large banks, central banks,

currency speculators, multinational corporations,

governments, and other financial markets and

institutions. The average daily trade in the global

forex markets currently exceeds US$ 2 trillion. Retail

traders (individuals) are a small fraction of this

market and may only participate indirectly through

brokers or banks.

Financial markets

Unlike a stock market, where all participants have

access to the same prices, the forex market is divided

into levels of access. At the top is the inter-bank

market, which is made up of the largest investment

banking firms. Within the inter-bank market, spreads,

which are the difference between the bid and ask prices,

are razor sharp and usually unavailable, and not known

to players outside the inner circle. As you descend the

levels of access, the difference between the bid and ask

prices widens. This is due to volume. If a trader can

guarantee large numbers of transactions for large

amounts, they can demand a smaller difference between

the bid and ask price, which is referred to as a better

spread. The levels of access that make up the forex

market are determined by the size of the “line” (the

amount of money with which they are trading). The

top-tier inter-bank market accounts for 53% of all

transactions. After that there are usually smaller

investment banks, followed by large multi-national

corporations (which need to hedge risk and pay employees

in different countries), large hedge funds, and even

some of the retail forex market makers. According to

Galati and Melvin, “Pension funds, insurance companies,

mutual funds, and other institutional investors have

played an increasingly important role in financial

markets in general, and in FX markets in particular,

since the early 2000s.” (2004) In addition, he notes,

“Hedge funds have grown markedly over the 2001-2004

period in terms of both number and overall size” Central

banks also participate in the forex market to align

currencies to their economic needs.


Banks
The interbank market caters for both the majority of

commercial turnover and large amounts of speculative

trading every day. A large bank may trade billions of

dollars daily. Some of this trading is undertaken on

behalf of customers, but much is conducted by

proprietary desks, trading for the bank's own account.

Until recently, foreign exchange brokers did large

amounts of business, facilitating interbank trading and

matching anonymous counterparts for small fees. Today,

however, much of this business has moved on to more

efficient electronic systems, such as EBS (now owned by

ICAP), Reuters Dealing 3000 Matching (D2), the Chicago

Mercantile Exchange, Bloomberg, and TradeBook(R). The

broker squawk box lets traders listen in on ongoing

interbank trading and is heard in most trading rooms,

but turnover is noticeably smaller than just a few years

ago.

Commercial companies
An important part of this market comes from the

financial activities of companies seeking foreign

exchange to pay for goods or services. Commercial

companies often trade fairly small amounts compared to

those of banks or speculators, and their trades often

have little short term impact on market rates.

Nevertheless, trade flows are an important factor in the

long-term direction of a currency's exchange rate. Some

multinational companies can have an unpredictable impact

when very large positions are covered due to exposures

that are not widely known by other market participants.

Central banks
National central banks play an important role in the

foreign exchange markets. They try to control the money

supply, inflation, and/or interest rates and often have

official or unofficial target rates for their

currencies. They can use their often substantial foreign

exchange reserves to stabilize the market. Milton

Friedman argued that the best stabilization strategy

would be for central banks to buy when the exchange rate

is too low, and to sell when the rate is too high — that

is, to trade for a profit based on their more precise

information. Nevertheless, the effectiveness of central

bank "stabilizing speculation" is doubtful because

central banks do not go bankrupt if they make large

losses, like other traders would, and there is no

convincing evidence that they do make a profit trading.

The mere expectation or rumor of central bank

intervention might be enough to stabilize a currency,

but aggressive intervention might be used several times

each year in countries with a dirty float currency

regime. Central banks do not always achieve their

objectives, however. The combined resources of the

market can easily overwhelm any central bank. Several

scenarios of this nature were seen in the 1992-93 ERM

collapse, and in more recent times in Southeast Asia.

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Investment management firms
Investment management firms (who typically manage large

accounts on behalf of customers such as pension funds

and endowments) use the foreign exchange market to

facilitate transactions in foreign securities. For

example, an investment manager with an international

equity portfolio will need to buy and sell foreign

currencies in the spot market in order to pay for

purchases of foreign equities. Since the forex

transactions are secondary to the actual investment

decision, they are not seen as speculative or aimed at

profit-maximization.

Some investment management firms also have more

speculative spe******t currency overlay operations,

which manage clients' currency exposures with the aim of

generating profits as well as limiting risk. Whilst the

number of this type of spe******t firms is quite small,

many have a large value of assets under management

(AUM), and hence can generate large trades.

Hedge funds
Hedge funds, such as George Soros's Quantum fund have

gained a reputation for aggressive currency speculation

since 1990. They control billions of dollars of equity

and may borrow billions more, and thus may overwhelm

intervention by central banks to support almost any

currency, if the economic fundamentals are in the hedge

funds' favor.

Retail forex brokers
Retail forex brokers or market makers handle a minute

fraction of the total volume of the foreign exchange

market. According to CNN, one retail broker estimates

retail volume at $25-50 billion daily, which is about 2%

of the whole market and it has been reported by the CFTC

website that unexperienced investors may become targets

of forex scams.

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