Forex Market Structure / Hierarchy

The forex market structure is quite different from other market structures which are centrally controlled such as stock market structure. The stock market structure has a centralized market unlike for forex which is decentralized.

Let’s have a look at how the stock market structure stands.

 The stock market structure has a monopolistic central exchange where its only one entity that controls prices. The stock exchange for example, the New York Stock Exchange( NYSE) and the London Stock Exchange( LSE).

  The forex exchange market structure.

Unlike the Stock Exchange Market , the Forex Market is a decentralized market where transactions are carried out over the counter (OTC) which means the FX market has no central exchange through which instruments are traded.

The market is competitively comprised of the price makers, dealers and traders of different liquidity sizes such as banks, brokers that facilitate currency trades by providing different buy and sell quotes  of different currency pairs and matching orders with the other traders.

The main participants are the large international banks, financial centers around the world, brokers and speculators.  The forex market is divided into levels and it is derived basing on the classification of participants and their motivation, regulations and their level of liquidity held at each level.

At the top is the inter-bank forex market which is made up of major banks and large commercial banks. The major banks include: Deutsche Bank, UBS,Citi Group, Barclays Capital, Morgan, Credit Suisse, RBS, Goldman Sachs, HSBC, Bank Of America and Morgan Stanley.

The inter-banks determine exchange rates of of currencies basing on their needs of supply and demand. The members trade trade currencies directly using the Electronic Networks; the Reuters Dealing 3000-Spot Matching and Electronic Brokering Services(EBS). They provide liquidity to the market to facilitate transactions. They are the market makers.  Prices in the network is good and only members can benefit from it.

The next is the financial and non financial participants. These include the forex brokers( STP/ECN),small  banks, hedge funds, mutual funds, pension funds,CTAs and large investors. These receive liquidity from the large banks and make it available for the traders. They frequently deal with the inter-bank markets. The brokers act as the intermediaries between the individual forex traders and the forex market marker.

The last is the speculators/traders. These are price takers. They trade on quotes made by the dealers or ECN who are the liquidity providers in the retail market. They speculate basing on technical and fundamental analysis to trade. They can hold relatively small accounts as low as $100.

The government or the central bank. The central bank plays in the background of the market and controls the value of the currency. Its role is to provide currency price stability, diversify forex reserves and make international payments on behalf of the government.

The central banks influence the forex market through exchange rates interventions by increasing and reducing interest rates, through monetary policy,(expansional monetary policy and contractional monetary policy) interventions.

They can also actively buy or sell their currency to affect the exchange rates.


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