How to be a TRADER Part 5: Understanding the Structure

Understanding the Structure of the Forex Markets

Right – Forex is probably new to you but you will have probably at some point looked at the stock market so let’s take a look at the structure of the stock market and then see how it compares with Forex.

 

 

 

The layout of the stock market is pretty simple. You have the Middleman who controls the price of stock. Every trade goes through him and his goal is to potentially play with prices to his own benefit. He doesn’t really care too much about the trader.

This Middleman has to make sure client orders are filled, BUT, what if the number of Sellers was far great than that of the buyers? Well at this point he would have a balance of left over stick which isn’t selling.

If he sees this as a possibility, he’ll basically increase the transaction cost to those sellers to put them off the sell-off, thus, accommodating his own need for balance.

Forex is different – you do NOT have to go through a centralised exchange with just one price – quotes will vary across various brokers, whereas with stocks there is just one price and then an ever manipulated and often large transaction fee.

There are hundreds and hundreds of options when trading Forex and lots of players; Brokers, Traders, Banks, ECN Brokers, more Traders, and so on and so forth. This is good for us because they all want our money, so we can use that to our advantage and get the best deal every single time we trade.

Now the structure of the Forex markets amid all this chaos is relatively logical in its layout. Let’s take a look…

The Forex Ladder:

The largest banks in the world Formulate what we call the Interbank Market. They actually trade with each other using two main electronic systems:

  • EBS – Electronic Brokering Services
  • Reuters Dealing 3000 – Spot Matching

Both of these two companies are in competition but they are so large its negligible – both have their unique strengths and both have their weaknesses.

Interestingly both have their own “Best Currency Pairs”.

On the EBS platform they are EURUSD, USDJPY, EURJPY, EURCHF and USDCHF. These will be their most liquid and readily available currencies.

Now in this interbank market, each bank can see what each other one is offering in terms of rates. But whether or not each bank can just pick the rate they want out of what’s on offer is another thing – like anything in life when it comes to finances, the better the credit rating you have and the better your relationship with credit agencies is, the more you get offered – these interbank relationships are no different.

Moving down to the Hedge Funds, Corporations, Retail Market Makers and Retail ECNs – these guys aren’t as close knit as the Interbank Market when it comes to their credit relationships, therefore, their transactions are done via commercial banks. Naturally this results in slightly higher rates for them.

And all the way at the bottom, you have Retail Traders – so traders looking to make more income from home, or those looking to trade for fun. Basically traders that are not part of an institutional organisation.

So we know the structure – next we will take a look at the different players in the Game of Currency.

 

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