Who Trades Forex?
A low entry barrier has made the foreign exchange market popular among retail traders. However, retail trading only makes up a tiny portion of the $7.5 trillion volume traded per day in the currency market. So, it is vital for a beginner trader to be aware of other major participants in the Forex market. This guide shares some information on the different categories of currency market traders and their roles.
Similar to any other financial market, retail and institutional traders make up the Forex market. They can be further classified as follows:
Retail Forex participants
Traders who use their own personal capital to trade in the Forex market come under this category. A retail trader will always trade his own capital through an account opened with a Forex brokerage firm. Retail traders contribute only 7.5% of the total volume traded in the Forex market. Ironically, the currency market would be largely unheard of without the participation of retail traders. Depending on the timeframe chosen for trading, a retail trader can be further classified as an intraday trader, swing trader, or an investor. Additionally, a retail trader can be a full-time or part-time trader.
Institutional Forex market participants
Institutional trading involves employing the capital of a firm to trade in the Forex market. Such a trading represents 92.5% of the volume traded in the foreign exchange market. Notably, generating returns from the currency market may not be the primary objective of an institutional level firm. Institutional level trading firms have a huge influence on the volatility and liquidity in the currency market. The different kinds of institutional level participants in the Forex market are described below.
Companies involved in cross-border exchange of goods and services will often have a need for overseas currencies to ensure unhindered imports and exports. Further, to limit risks related to exchange rate volatility, multinational companies often hedge their positions in the FX market. Large corporations execute contracts worth billions of dollars regularly to meet business needs and offset their risks.
Hedge funds are basically short-term speculators in the Forex markets. They are known for their quickness in entering and exiting a trade. Most of their entries are usually based on high-impact news such as NFP, unemployment change, inflation, retail sales, and GDP data.
Pension and insurance companies
These are firms which aim to earn a profit slightly above the savings rate offered by banks. Thus, pension funds and insurance companies prefer to trade on the long-term trends in currency pairs. They usually take great precaution in handling public money as they are accountable to the government in most cases.
Most of the large commercial banks have a trading desk. They trade in the FX market for their high net-worth customers and also for themselves. The banks are interconnected through the Electronic Brokerage Service (EBS) or Reuters platform. The inter-bank Forex market actually represents the core of the spot currency market where big corporations, banks, hedge funds, and other non-banking financial institutions transact for their currency needs.
Central banks are autonomous bodies that frame the monetary policy in the country they represent. However, they are accountable to the elected government of a country. The mandate of a central bank is usually decided by the government. Thus, trading decisions taken by a central bank may or may not result in a profit. When the currency of a country becomes too volatile, a central bank may intervene in the Forex market practically after verbal messages have failed. The intervention will be in the interest of the country and usually against the market’s perception. The central banks of developed economies theoretically have unlimited buying and selling power. The central banks also influence the exchange rate by raising or lowering the benchmark interest rates.
The goal of a Forex market participant may be hedging risk, generating profit, boosting economic growth, or any other purpose. That makes it unique from equity markets, where all the participants buy or sell stocks to generate profits.