In the equity market, individual investors trade only with institutional and other individual investors. This is not the case with Forex trading as there are more participants in the currency market than there is in the equity market. Thus, identifying market participants and their motivations and functions is important.
Central Banks and Governments
Arguably, these are the most influential players in the currency markets. In many countries, the central bank represents the government and acts in accordance with its government’s policies and initiatives. However, there are some governments that prefer a more independent central bank. They work in tandem to keep interest rates at a minimum, curbing inflation, and spurring economic growth.
Regardless of the central banks’ degree of independence, governments frequently consult them specifically on matters involving monetary policies. Thus, central banks and governments are usually one as far as monetary policies are concerned.
Other Banks and Financial Institutions
Banks make up a big contingent in the Forex markets. Individuals in need of small amounts of foreign currency typically just deal with the market’s fluctuations. However, a big chunk of the big ticket transactions happen between banks.
The interbank market is dominated by the larger banks. This is where the exchange rates that reach individual investors’ trading platforms are set. It represents banks with credit relationships that trade among themselves, so the bigger banks have access to more credit and better rates that it can offer to its clients on its own. In general, banks are considered as dealers as they buy and sell currencies at the bid and ask prices.
Among the major clients of banks are businesses with international dealings. Whether the business is buying from a foreign client or selling to an overseas supplier, it has to deal with the currency prices’ volatility.
Among the things that businesses hate most is uncertainty. For many multinational companies, managing their Forex risk is a serious problem. To illustrate, a French company places an order for equipment from a manufacturer in Japan. The order requires a 50% payment in Japanese yen prior to delivery which will be after a year to allow for manufacturing. Because of the possibility of wild price fluctuations that can happen in a years’ time, the French company has no way to determine for certain if it will have to shell out more euros when the time for payment comes.
Speculators are another type of Forex market players. Instead of exchanging currencies to be used for international dealings or hedging against price movements, they make money from Forex trading by taking advantage of the currencies price fluctuations.
The billionaire George Soros, famous for his speculations on the drop of the British pound, made $1.1B in less than one month. On the other side of the fence, derivatives trader Nick Leeson, who caused the collapse of his company by losing $1.4B on speculative futures contract positions.