The process of trading currencies around the world is no longer simply a matter of banks exchanging currencies amongst themselves and today involves a very large number of different players with a wide variety of reasons for wishing to trade in currencies. Some for example will need to exchange currencies for the traditional purpose of buying goods and services overseas, but others will be participating in the market simply to earn short term profits from movements in the market or to influence exchange rates.
Whatever the reason for a player’s participation in the market, this diverse group affects the supply and demand within the market, and thus the exchange rates at any given moment in time, and so it is important to understand just who the key players are. Here, we look at the most important players – the commercial banks.
The commercial banks account for by far the largest proportion of all trading of both a commercial and speculative nature and operate within what is known as the interbank market. This is essentially a market composed solely of commercial and investments which buy and sell currencies from each other. Strict trading relationships exist between the member banks and lines of credit are established between these banks before they are permitted to trade.
Commercial and investment banks are a fundamental part of the foreign exchange market as they not only trade on their own behalf and for their customers, but also provide the channel through which all other participants must trade. They are in essence the principal sellers within the Forex market.
One important thing to remember is that commercial and investment banks do not only trade on behalf of their customers, but also trade on their own behalf through proprietary desks, whose sole purpose is to make a profit for the bank. It should always be remembered that commercial and investment banks have exceptional knowledge of the marketplace and the ability to monitor the activities of other participants such as the central banks, investment funds and hedge funds.
Of course the commercial banks have been at the center of the Forex market for many years now and their role has remained basically the same throughout this time. However, the arrival of the first electronic brokering systems (Reuter’s ‘Monitor Dealing Service’ in the early 1980s and Reuter’s ‘Dealing 2000-1’ in 1989) started to change the face of the market. It was however the arrival of Reuter’s ‘Dealing 2000-3’ system in 1992, quickly followed by the launch of ‘Electronic Brokering Services (EBS)’ in 1993 with the ability to automatically match buy and sell quotes from dealers that changed the face of the Forex market and the very nature of the market.
Electronic trading systems now allow dealers to conduct a number of trades simultaneously and to trade with much tighter spreads, greater efficiency, lower costs and, most importantly, far greater transparency than was provided by the old telephone dealing system.
The advantages of electronic dealing are clear for all to see, but it is the accessibility of the system and that fact that much greater access has been granted to it that has allowed many more players to enter the market alongside the commercial and investment banks.