The Foreign Exchange Market

By Peter Pontikis

‘Foreign exchange,’ ‘Forex’ or ‘FX’ is the home of the inter-bank and wholesale market for exchanging one currency for another and thrives in what is an enormous sea of money. It trades across the globe in over 100 currency pairs in the largest of the world’s financial markets!

Institutional FX

Basically, Institutional Forex is the big end of town when it comes to foreign exchange. Here, we are talking about a market with daily transactions in excess of 3 trillion dollars. To be ‘big’ in this business is to talk about huge amounts of funds being traded in an instant. While it is standard to trade in 5 to10 million dollar parcels, quite often 100 to 500 million dollar parcels get quoted. But what is important (and comforting) to note, is that even financial institutions are vulnerable to market moves and they are also subject to market volatility. In a practical sense, what this means is that because the market is simply too big, no one player can hope to control this largest of the world’s financial markets.

No one is bigger than the market – not even the major global brand name banks can lay claim to being able to swing the markets. Thus, so-called ‘insider’ information is not only very hard to come by, it is quite doubtful that even if someone had it would it be anything but a ‘blip on the screen’ with minimal value.

The Participants


Whether big or small scale, banks participate in the currency markets from the point of view of managing their own foreign exchange risks and that of their clients. They also speculate in the currency markets should their dealer/traders have a particularly strong view of the market. What probably distinguishes them from the other players is their unique access to the buying and selling interests of their clients. This knowledge can provide them with insight to the likely buying and selling pressures on the exchange rates on a particular day or other small timeframe.

Deals are transacted by telephone with brokers (we will talk about these people later) or via an electronic dealing terminal connection to their counter party. The usual transaction time is somewhere between 5 and 10 seconds. The skills of the foreign exchange dealer demands agility of reflexes and decisiveness, particularly when we are talking about transaction sizes of multi-million dollar amounts.

The ostensible role of the foreign exchange dealing desk in a bank or other financial company is to make profits trading currency directly and in the managing of in-house and clients’ trading positions. However, their roles will also include periodic hedging or arbitrage opportunities.


The foreign exchange broker acts as an agent in the same way that a stockbroker acts in the equities market. The slight difference being that they usually confine their activities to acting between interbank market participants and they do not accept orders from corporate clients.

Through their extensive and direct electronic contacts with the banks, brokers take and match currency buying and selling orders of their bank clients. Of course, this is done for a fee. The value to the banks using this service is that it is usually done quickly because orders can be placed and dealt in a matter of seconds, and it avoids the bank having to deal on a competitor’s price and pay the ‘spread’ on the transaction.

Many of these brokering functions have been significantly computerized, cutting out the need for human handling of the orders.

Central Banks

The majority of developed market economies have a central bank. The role of a central bank tends to be diverse and can differ from country to country. In Singapore for instance, it is the Monetary Policy of Singapore (or MAS for short) and is charged with the responsibility of maintaining an orderly market for the national currency, which is known as the Singapore dollar.

In a practical sense this involves monitoring and checking the prices dealt in the inter-bank market. Sometimes, they even ‘test’ market price by actually dealing to check the integrity of the quoted prices. In extreme circumstances where the central bank feels prices are out of alignment with broad fundamental economic values, the central bank may ‘intervene’ in the market to influence its level directly. The intervention can take the form of direct buying to push prices higher or selling to push prices down. Another tactic that is adopted is stepping into the market and ‘jawboning,’ or commenting in the media about its ‘preferred’ level for the currency.

Bankers, fund managers and companies all tend to respect the opinions of the central banks (if not always agreeing) as their sheer financial power to borrow or print money gives it a huge say in the value of a currency. The opinions and comments of a central bank should never be ignored and it is always good practice to follow their comments, whether it in the media or on their website.


As the name implies, this represents companies and businesses of any size from a small importer/exporter to a multi-billion dollar cash flow enterprise that are compelled by the nature of their business to engage in commercial or capital transactions that require them to either purchase or sell foreign currency.

Fund Managers

These participants in the currency markets are basically international and domestic money managers. They tend to deal in the hundreds of millions, as their pools of investment funds tend to be very large. Because of their investment charters and obligations to their investors, they are constantly seeking the best investment opportunities for those funds.

In short, they invest money across a range of countries and class of investments on behalf of a range of clients including pension funds, individual investors, governments and even central banks. This segment of the foreign exchange market has come to exert a greater influence on currency trends and values as time moves forward.

Hedge Funds

This is a special class of fund manager and has come to be referred to by their more appropriate name of ‘absolute return funds.’ These high-end funds are generally more concerned with managing the total risk of a pooled investment, than just relative performance, which preoccupies traditional fund managers. They tend to be more aggressive in their investment approaches, and will be found adopting investment strategies such as borrowing to realize leverage potential and will exploit the use of derivatives. But they are relatively small (though high in profile) in comparison to traditional funds.

Major Dealing Centers

This list of participants does not necessarily reside in the one geographic center. Indeed, as the global Forex clientele is quite dispersed and, as a consequence, so is the market as a whole. When it comes to Forex it is simply not possible, as is the case for the equities markets, to be located on particular formal exchanges or national center points. In practice, the foreign exchange market is made up of a network of dealers and traders clustered in various hubs around the globe. They are linked via computer terminals, telex, telephone and even the Internet or Internet-based dealing platforms to form a diverse global market where prices and information are freely exchanged. Simply put, there is no single ‘center’ in this market.

Despite this, the foreign exchange market has prominent and major dealing centers located in London, New York and Tokyo. We generally call these the ‘major centers,’ not just because of the sheer size of the volumes and number market participants in their vicinity, but also because the happenings in these places tend to influence other dealing centers around the world.

These other smaller centers include such cities as Sydney, Singapore, Hong Kong, Switzerland and Frankfurt and they tend to take up the remaining balance of traded global currency flow. Thus, these three main and five minor trading centers are the major regions that set the pace of currency transaction across the globe.

Now, it is also worth mentioning that this list has practical implications for Forex dealing regardless of ones level of sophistication. It forces everyone, including the small retail trader to be aware of the most recent leading center’s trading activity. In the case of a Forex trader in Asia, it means at the start of the trading day, looking to the U.S. market action will give some clue as to the likely direction of the local morning session. A few hours into the session, it is normal to keep an eye on the course of action emanating from the Tokyo market, which is to our north as it takes its part in influencing the course of Asian currency trading trends.

Do not forget, the above applies not just to market activity, but also inactivity. So if these centers are together or separately on holiday, do not be surprised when trading tends to go quiet. Holidays, like economic statistics have a bearing on the general flow or lack of business and price activity. Hence it is a good idea to keep a calendar of major international holidays near when doing your market research and within easy reach to help you recall them in planning particular trades.

The Inter-Bank World and Direct Dealing

To be considered a foreign exchange market marker, a bank must be prepared to quote a two-way price (i.e. a bid and offer). Of course, the bid is the market makers ‘buying’ price and their offer price is their ‘selling’ prices to all enquiring market principals, whether or not they are themselves market makers in a particular currency. The price rates are quoted over the telephone, electronically via digital dealing platforms or, less frequently nowadays, by telex to dealers in other countries.

Market markers ‘earn’ their money by the difference between their buying price and their selling price, which is called their ‘spread’ and these spreads are extremely fine for large inter-bank parcels. For instance, in the $Australian dollar on a parcel of say 10 million $US dollars, the spread is only ‘5’ in the fourth decimal place. In such a case, it is quoted as 0.8005 / 10, the difference between the two prices adds up to $5,000 (US) dollars profit to the market maker.

This is an example of a typical Reuter’s terminal based conversation. It shows how clipped the conversations sometimes are between inter-bank dealers. It may also look a little like jargon. However it not really that hard to follow once you understand the basic intention of either side.

Inter-bank foreign exchange dealing

Briefly, Bank A in this conversation is the price taker, that is, he/she is asking for Bank B’s price in the Australian dollar versus the US dollar, simply by saying ‘oz.’ The amount that they wish to transact is 10 million Australian dollars as the base currency in the quote.

The answer that Bank B provides is simply the two-way price quote as the last two decimal places. In this case, it is ‘5 –10.’ However to avoid ambiguity, Bank A has requested confirmation of the big figure of the price. Bank B responds with 8005- 10, which is the long form of the price.

At this point Bank A states what ‘side’ it would like to deal; ‘at 5’ meaning the bid side. Now, we know that Bank A wants to sell 10 million Australian dollars at 0.8005 US per Australian dollar. Bank B confirms the deal as ‘done’ and politely thanks him. Bank A simply replies with ‘bye bye for now’ short formed to ‘bibifn.’

The New Generation of FX Brokering and Trading

One of the great challenges to the institutional foreign exchange market ha s been the emergence of the Internet and Internet based trading platforms. Not just in terms of enabling access to Forex markets for the retail trader and investor, these changes have challenged the very domain of the institutional investor and how they handle their foreign exchange business.

On the electronic brokering side, systems like EBS, which is short for ‘electronic brokering system’ and price information vendors like Reuters are providing computer platforms where bank dealers and traders can input their prices directly into the computer without the need for a human broker to take their prices down. This is the process of collecting prices from all contributing banks automatically. And because of the instantaneous method of these platforms, prices are not just indicative, but they are the actual dealing prices. This has, in turn, significantly increased the speed of the process of price discovery and also contributed to the market’s overall transparency, while at the same time reducing the costs to participating banks.

Online Portals and the Rise of Electronic Brokers

As if the changes in the Forex brokering industry were not enough, increasingly and with the unstoppable advances in technology, as evidenced by the emergence of electronic brokering platforms such as EBS and Reuter’s dealing systems, the task of customer/order matching is being systematized. This has led to the entire human element of the brokering process being virtually dispensed with altogether. This does not mean that humans do not decide to put on an order or take them off – that still stays – but the people involved between when an order is put to the trading system up until when it is dealt and matched by a counter party is being reduced by technology. This is called ‘straight through processing’ or, in other words, the automatic processing of an order as soon as it becomes ‘live.’

Forex Internet portals do this automated processing and, in doing so, they have made Forex trading available to a much wider audience of traders and not just bank traders either. Because of the competitive pressures of the market place, Forex participants of all types are being given a choice of available trading and processing systems for all scales of transactions. Some these new trading platforms include FXall, FXconnect, Atriax,, and all of them are easily available on the web for your further research.

These portals provide a crucial step for the retail trader. They allow foreign exchange market participants (importantly the corporations and fund managers) to by-pass bank dealers in being able to access the market for foreign exchange directly. This cuts out the middleman and reduces costs substantially.

These platforms are undeniably in their market infancy and for this reason, they exhibit a large diversity of available structures. For example, a bank usually manages a bi-lateral Forex platform, but the prices that displayed are those of its customers. Conversely, a multi-lateral system has no managing bank or agent and is purely an unofficial foreign exchange trading system. Naturally, there are regulatory and privacy issues in dealing with these innovative platforms and their offerings, but certainly in the absence of a worldwide ban, they have emerged as a market fact of life that is probably here to stay. One thing is certain though; the marketplace for foreign exchange has changed allowing the retail Forex trader to participate and to actively trade Forex.


The global currency markets are inhabited, but not necessarily controlled by banks. Other players include brokers, corporations, fund managers, hedge funds and central banks as well as retail investors. Though their scale is huge compared to the average retail Forex trader, their concerns are not dissimilar to those of the retail speculators. Whether a price maker or price taker, both seek to make a profit out of being involved in the Forex market.

We saw how market makers in the financial markets are forced to provide competitive twoway prices to their clients and are not immune to the technological changes afoot in the industry. These changes pave the way for a lot of interbank dealing now being brokered electronically using various platforms. A phenomenon that merely mirrors what is already seen at the retail level of Forex trading as the benefits of the new technologies spread democratically.

Peter Pontikis is the Group Treasury Strategist for Suncorp Banking. He has also authored a book on trading foreign exchange and is the current treasurer of the International Federation of Technical Analysts (IFTA) He can be reached on ©2007, Reprinted with permission of Forex Journal magazine.