Of all the financial markets, spot forex market maybe considered as the most pure in the sense that supply and demand is strictly what determines the prices. Spot means that both the buyer and the sellers agree on a certain price and make the transaction on the spot without any delay. The spot forex market is an over the counter market. The spot forex market is a decentralized network of buyers and sellers. There is no physical central exchange that acts as a central clearing house.
Stocks, options and futures all are traded on centralized exchanges with a clearing house as the intermediary. This brings a lot of order in these markets. Unlike the forex futures trading that is carried out through the exchange like CBOT, CME etc, over the counter in spot forex means that the buyers and sellers make a binding contract with each other after agreeing on the price and this is not carried through an exchange. The buyer and sellers can agree on any price!
What are the advantages of a centralized market over OTC market? There is a better price discovery in a centralized market and there is trading anonymity something that big players want to hide their trails. There are several other advantages of a central exchange too like the counterparty risk for the trade is reduced. Forex traders in the spot forex market carry out their activities by dialing directly with one another or through brokers on telephone or internet.
For all the practical purposes, the spot forex market is unregulated and free of distorting red tape. The sheer size of the daily trading volume something like $3 trillions means that the government and the central banks interventions have little long term effect on prices. Chicago Mercantile Exchange (CME) along with Reuters launched the world’s first centrally cleared global forex market place in 2007; FXMarketSpace. CME will act as the clearing house and guarantee the performance of all the contracts for both buyers and sellers in this centrally cleared system.
However, only sophisticated investors with net worth of more than $20 Million can trade on the FXMarketSpace. Unfortunately FXMarketSpace was supposed to be an institutional trading platform and not open to retail forex traders. However, the joint venture between CME and Reuters could not succeed and was closed down in 2008 due to lack of liquidity. Forex market is an efficient market. The spot forex market has never been a value creator rather it is a vehicle for other transactions. For example, a US portfolio manager buying Japanese stocks or an Italian company buying raw material from Brazil are inadvertent parts of the forex market.
There are many players involved in the spot forex market. The spot forex market has long been the playground of only the biggest and the baddest global banks. At its core, the spot forex market is a credit market. The dominance of big banks is unlikely to be challenged soon. Recently NFA (National Futures Association) had also passed certain new rules that make it more skewed against the small investor like you and me. The spot forex market is still skewed against the retail forex trader. Why is it so?
The spot forex market has always been an unfair playing field for the big boys. It became possible to introduce trading platforms for the retail investors with the advent of the internet. Previously spot forex trading was the playfield of the big banks, multinationals and the hedge funds.
The forex market differs from other traditional financial markets. Things deemed illegal in most of the other financial markets are simply considered part of the game in the forex market. Insider trading, front running, price shading etc are all regularly seen in forex trading and have no legal repercussions whatsoever. Retail spot forex is seeing a lot of growth in the recent years. A mushroom growth of online forex brokers took place. Many did not have even enough capital with them to start the brokerage business. Most of these forex brokers behave like bucket shops. But this is the way; the spot forex market has developed over the years.
Why these players trade forex? What type of advantages they have over the retail forex traders? It is essential for you that you understand the nature of the spot forex market and who are the main players. Off balance sheet earnings are the declared aim of most banks and spot dealing in forex which represents a high loss potential but practically no credit risk falls in that category.
Over the counter (OTC) means that the spot forex market is spread all over the globe with no central location! Over the counter nature (OTC) of the spot forex market means that currency transactions do not take place at any single place. No government oversight and no central deal book to compare trades means that the banks can pretty much do whatever they want to their unsuspecting customers.
In order to understand a banks motivation for get involved in spot forex trading, all you have to know is that by combining large forex dealing desk with a decent trading group, you are talking about billions of dollars in profits. A player’s access to the spot forex market depends on the quantity of transactions of large amounts of money. Players in the spot forex market range from those who trade billions of dollars daily to those who only trade just a few thousand dollars daily. Now these are the main players in the forex market against whom you as a retail forex trader will be competing.
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October 13th, 2009 at 5:13 am
Commenting usually isnt my thing, but ive spent an hour on the site, so thanks for the info
Greetings from Tim.
October 13th, 2009 at 8:14 am
Hello
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October 16th, 2009 at 5:39 am
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October 23rd, 2009 at 12:34 pm
Excellent article, bookmarked for future referrence