Understanding the Decentralised Interbank Foreign Exchange Market

Read full article here...

 

Introduction
As we noted in our article ‘What is the Foreign Exchange Market’, the FX market has an average daily volume of roughly $2 Trillion making it the largest financial market in the World. It is not just the size of the market that makes it interesting but also the way it operates; the forex market is completely decentralised. This means that, unlike centralised exchanges such as the NYSE and LSE, there is no central location where each transaction can be traced and recorded nor do currencies have specialist market makers responsible for providing quotes for the entire market. Instead, the entities that act as market makers for the currency market are the World’s largest banks. These banks carry out transactions between each other on a regular basis, hence the term ‘interbank market’.

What Does This Mean For Us?
The vast majority of individual speculators and traders do not have access to interbank prices the same way a bank does. Access is reserved for large hedge funds and corporations that have established credit relationships with the banks. One example of such a corporation are the retail forex brokers that service the individual trader. These are the brokers that you open an account with when you want to trade FX. Examples include Easy Forex, Capital Spreads and FXCM. These brokers use the interbank prices as the basis for the quotes they offer to you, their customers.
Although forex brokers are essentially operating in a decentralised, and in part deregulated market, they are governed and monitored by organisations such as the Commodity Futures Trading Commission and the National Futures Association (NFA) in the United States and the Financial Services Authority (FSA) in the United Kingdom. Strict financial standards and processes are imposed on retail brokers by these official bodies.

 

Stage 1	Client calls the sales desk with an order stating size, currency and direction.
Stage 2	The sales desk checks with the trading desk for a quote based on the client's specific requirements.
Stage 3	The sales desk relays the quote to the client for a final decision.

 

On a trading desk there are usually one or more market makers responsible for each currency pair. The number of dealers depends on the amount of volume seen during the trading day. For example, EURUSD (Euro US Dollar) and USDJPY (US Dollar Japanese Yen) currency pairs are likely to have two dealers each; one primary who gives quotes for the largest orders and a secondary who quotes for smaller orders. These dealers will act as specialists for their particular currency pair so that they become ultra familiar with the other players in the market and the way the pair moves. In general the dealer responsible for the USDJPY pair will make quotes for all JPY crosses such as CADJPY (Canadian Dollar Japanese Yen) and GBPJPY (Great Britain Pound Japanese Yen). The trading desk team also includes one dealer who handles AUD (Australian Dollar) and NZD (New Zealand Dollar) (out of Pacific trading hours, there are likely to be more during Australian and New Zealand working hours) and one final dealer responsible for exotics such as South American and African currencies. In order that client positions can be monitored 24 hours a day, each bank’s trading desk will pass on client position information to their foreign counterparts. i.e. At London close orders are passed to New York and so on.

 

Read more about forex trading training