Interested in knowing all about forex trading? You’ve landed on the right page!
In this blog we shall present a broad overview of everything related to the subject. You will get to know what forex trading is, how you can participate in it, the regulations that apply, the key entities that are involved in trading operations etc.—in short, everything you need to know about this widely-known but little understood activity.
Who knows, it might even inspire you to become a full-time forex trader!
Let’s get started.
What is forex?
Forex is an over-the-counter (OTC) market. It is an interbank market, meaning it is run electronically or via telephone between various banks and other high volume market participants continuously over a 24-hour period.
Spot forex is spread across the globe with no central location.
The volume of forex trading amounts to more than $5 trillion a day, according to data from the Bank of International Settlements (BIS), which is considerably more than what is traded on the New York Stock Exchange. The most commonly traded currency is the US dollar, which features in nearly 80% of all forex trades.
Approximately 90% of forex trading is speculative. Forex volume exceeds global equities trading volumes by up to 25 times.
Participants
Participants in a foreign exchange market can be categorized into five major groups—fintech providers, prime brokerage providers, liquidity providers, brokers, and traders. There are also the regulators, who are not exactly participants but are a major external factor influencing the market.
Regulators
It is not easy to regulate a market the size and scope of the forex market, which is operational 24 hours a day. Several state-owned and independent bodies monitor forex trading around the world.
Some major global regulators are:
- United States—The National Futures Association (NFA), and the Commodities Futures Trading Commission (CFTC)
- United Kingdom—The Financial Conduct Authority (FCA)
- Japan—The Japanese Financial Services Agency (JFSA)
- Australia—The Australian Securities and Investments Commission (ASIC)
- Canada—The Investment Industry Regulatory Organization of Canada (IIROC)
- Singapore—The Monetary Authority of Singapore (MAS)
- Hong Kong—The Securities and Futures Commission (SFC)
Brokers
A forex broker enables retail forex traders to connect with the forex market via a trading platform that allows them to buy and sell foreign currencies. The forex broker also provides a forex trading account to each trader free of charge. This account is where the trader will keep the capital to be used for forex trades.
Currencies are always purchased in pairs. If someone buys EUR/USD, it simply means that the trader expects the US dollar to lose value compared to the Euro over time. They will gain money when the Euro becomes worth more in terms of the US Dollar than when the trader first bought the pairing.
It is forex brokers that enable traders to link up with the banking network and purchase a currency pair. Before forex brokers arrived, people wanting to engage in forex trade required large funds and bank support to carry out their operations. Forex brokers make their earnings through commissions every time a trader makes a transaction.
Advancements in financial technology and changes in regulatory framework have propelled a few trends when it comes to forex broking:
- Many small brokers have moved their business to loosely-regulated jurisdictions in order to retain their clients.
- Many large brokers have amended their processes in order to comply with regulatory framework and abide by the new rules.
- The trend is inclined toward more ‘civilized’ trading, i.e., small brokerage companies, which operate using certain quasi-legal schemes, are being driven out of the market.
- Price transparency is continuously changing the manner in which brokers operate.
Brokers’ proprietary technologies and convenience of trading are two of the major factors that influence the selection of brokers by traders.
Traders
Advancements in technology have enabled private and retail traders to make transactions on their own. Today, you only require an internet connection to gain access to live stream prices and manage your own portfolio. Electronic forex trading has started flourishing post the 2008 financial crisis. Digital platforms offer ease of access and increased transparency to retail traders, who view forex trading as an investment class that is in the same league as bond and equity asset classes.
Here are a few more interesting trends that have been observed with respect to forex traders:
- The demand for social trading services, which allows for sharing the results of trading, charts, and trading signals, is pretty strong.
- Traders are also interested in algorithmic trading. Certain services provide traders with an opportunity to create their own trading robots even without programming skills.
- Advancements in digital communications and mobile technology have transformed the trading landscape, making trading far more accessible. Today, mobile-based trading constitutes almost 60% of all transactions.
- A demographic shift is occurring in the industry and younger traders are actively participating in the business. Statistics also reveal that 1 in every 10 traders is female.
Fintech Providers
Technology is the most pronounced element in current-day forex trading. Blockchain, mobile technology, algorithmic trading, artificial intelligence, robotics etc. have changed the way trading is done for ever. These new technologies have impacted not just the financial space and boosted investment options, but have also led to the creation of advanced computer programs capable of generating investment suggestions based on your inputs about your needs, income, and investment attitude.
Certain programs also allow for the automation of analysis and trading. Automated trading algorithms enable traders to code the parameters of their trading strategies. These highly complex algorithms provide users with simple-to-use tools that enable them to hone their trading strategies and make the most of their market presence.
Copy trading is a sort of social investing that allows traders to build a network of followers with whom they can share their market projections and trade calls. This makes it easy for followers to duplicate the trades that are made.
The real power of technology is apparent in terms of accessibility to services, positive user experience, and fruitful engagement with other market participants. In other words, progress in technology has enabled a more social and human transactional experience.
Here are a few important ways in which fintech has changed the scenario:
- Blockchain technology has been a big game-changer, resulting in improvement of both trading conditions, and the performing of clients’ financial operations.
- Brokerages with their own proprietary technology and trading infrastructure have been able to thrive in the market.
- Fintech is helping various participants dig deeper into big data and make decisions based on it.
- The arrival of multi-asset cloud platforms allows trading in a different financial market through a web terminal.
- Artificial intelligence tools offer new insights into customer intelligence.
- Robotics and other technology components are set to start a wave of ‘re-shoring’ and localization.
- Cyber security has emerged as one of the top priorities.
- Technology has facilitated real-time decision-making.
A-Book and B-Book Traders
Almost all brokers are involved in both A-Book and B-Book trading. It’s never the case that some are A-Book traders, while others are B-Book traders.
A-Book system involves the broker passing trades through to the interbank market, where they are filled by a liquidity provider. If you are buying a pair, the broker places the order with the liquidity provider who fills the order.
In a B-Book trade, brokers fill the trade internally from their balance sheet at the level of the dealing desk, thus assuming the risk on their own company capital. When the traders in the B-book liquidity bucket lose, the brokers win.
Liquidity Providers
Institutions that offer currencies for sale in the interbank market are termed liquidity providers. These are the major banks such as Nomura, Deutsche Bank, UBS, Bank of America, etc. They contribute to price stability and boost liquidity by enabling traders to buy and sell at any price level.
Tier-1 liquidity providers are leading investment banks with extensive foreign exchange departments. They roll out the tightest spreads for the currency pairs they provide liquidity on. They may often trade positions to earn rather than relying on the bid/offer spread to make profits.
Prime Brokerage
Prime brokerages are top financial institutions with the wherewithal to offer services to other mega-sized financial institutions. The likes of Goldman Sachs, Merrill Lynch, and Morgan Stanley serve as prime brokerages.
Financial markets with very active trading require prime brokerages to facilitate transactions between large financial brokers and investors. When selecting a prime brokerage, important factors include costs, confidentiality, scope of access to markets, and general customer service.
Most prime brokerages offer trade clearing and settlement services to their clients.
Looking Ahead
Since the regulatory environment is set to strengthen in future, you may expect more transparency in trading. This will encourage market players to consolidate. However, since there is enough room for expansion, the market will continue to grow. Rapid advancements in fintech are another factor that will continue to influence how trade is done.
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