You’ve probably heard the words “decentralized” and “unregulated” used countless times to describe the forex market.
These terms refer to the structure of the forex market and how it doesn’t have a central body that regulates its activities. But these words by themselves don’t really capture the forex market’s essence – its various market players and the flow of trades.
In this lesson, you’ll learn the different components that make up the forex market’s structure in more detail.
If you’ve traded in the stock market before trading forex, you may have noticed how markedly different they are.
The stock market’s structure is often used as a contrasting point for the forex market. While forex and stocks both deal with the exchange of assets, their similarities end there.
As stocks are generally traded on centralized exchanges, all trades in an exchange go through a single entity – the exchange’s specialist.
This specialist (or Designated Market Maker, if you’re trading on the New York Stock Exchange) is responsible for fulfilling clients’ orders.
Having only a singular point of exchange makes it possible for specialists to tamper with prices for their benefit.
Suppose that the number of sellers in an exchange surpasses the number of buyers. If this happens, the specialist would be burdened with unsold stocks because of the imbalance of buyers and sellers.
To avoid this situation, the specialist may widen the spread or impose higher transaction costs to prevent the influx of sellers.
In simpler terms, the specialist can manipulate price quotes and transaction fees for their own benefit.
Unlike stocks, you don’t have to go through central exchanges to trade in the forex market. Instead, you can choose from a myriad of available brokers.
This means you don’t have to buy (or sell) assets at the price one broker may quote – you can find other brokers with better prices!
As you can freely choose where to trade among a large number of options, brokers are forced to make their quoted prices as competitive as possible. It’s up to you to find the best prices available.
That’s just one among the many advantages that the forex market’s decentralized nature offers.
You may think that decentralization will make the forex market’s structure disorganized. However, that’s far from the truth.
The market has an ordered hierarchy of participants, with the largest players (multinational banks) at the top and the smallest (retail traders) at the bottom.
The large commercial banks at the top of the ladder comprise the forex market’s interbank network or market. These big-time players include the world’s premier banks, such as Citi, Barclay’s, and JPMorgan.
These banks trade currencies with each other directly or through electronic brokers, like EBS Market and Reuters.
These electronic brokers vie with one another for market shares. Although they offer most currency pairs, some are more liquid in one platform than others.
For instance, the EUR/USD, USD/JPY, EUR/JPY, and USD/CHF currency pairs are more liquid on the EBS platform.
Meanwhile, Reuters’ platform offers more liquidity for the GBP/USD, AUD/USD, EUR/GBP, USD/CAD, and NZD/USD currency pairs.
At the opposite end of the hierarchy are the retail traders. Historically, only the largest financial institutions could participate in the forex market, and regular individuals couldn’t even dream of it.
However, the rise of retail brokers, electronic trading, and the advent of the internet made it possible for retail traders to enter the forex market.
Between the large commercial banks at the top and the retail traders at the bottom are the hedge funds, retail market makers, and retail ECNs.
In the next lesson, you’ll learn more about these market players.