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Conversely, in the forex market, trades are made in the specific time zones of that particular region. For example, European trading opens in the early morning hours for U. As a result of the currency market's hour cycle, spanning multiple trading sessions, it's difficult for one large trade to manipulate a currency's price in all three trading sessions. Regulators The international nature of the interbank market can make it difficult to regulate. However, with such important players in the market, self-regulation is sometimes even more effective than government regulations.
The CFTC regulates brokers to ensure that they meet strict financial standards. Interbank Bid-Ask Prices Currencies are quoted in pairs using two different prices, call the bid and ask price. The bid and ask prices are similar to how equities are traded. The bid price is the price you would receive if you were selling the currency and the ask price is the price you would receive if you were buying the currency.
The difference between the bid and ask prices of a currency is known as the bid-ask spread , which represents the cost of trading currencies minus broker fees and commissions. The primary market makers who make the bid and ask spreads in the currency market are the largest banks in the world. These banks deal with each other constantly either on behalf of themselves or their customers—and they do so through a subsegment of the forex market known as the interbank market.
The interbank market combines elements of interbank trades, institutional investing, and trades from corporations through their financial institutions. The buy and sell rates from all of these players and their transactions form the basis for prevailing currency rates—or the market—from which pricing is determined for all other participants.
The competition between the interbank institutions ensures tight bid-ask spreads and fair pricing. Individual Forex Investors Most individuals can't access the pricing available on the interbank forex market since their transaction size isn't large enough to be traded by the interbank players. In other words, the forex market is a volume-discounted business, meaning the larger the trade, the closer the rate will be to the interbank or market rate.
However, the interbank participants are important to retail investors since the more players involved, the more liquidity exists in the market, and the greater likelihood for price fluctuations, which can lead to trading opportunities. The added liquidity also allows retail investors to get in and out of their trades with ease since there's so much volume being traded.
The Interbank Players Most of the total forex volume is transacted through about 10 banks. The elite group of institutional investment banks is primarily responsible for making prices for the bank's interbank and institutional clients and for offsetting that risk with other clients on the opposite side of the trade. Each bank is structured differently, but most banks will have a separate group known as the Foreign Exchange Sales and Trading Department. The sales and trading desk is generally responsible for taking the orders from the client, obtaining a quote from the spot trader and relaying the quote to the client to see if they want to deal on it.
Although online foreign exchange trading is becoming more common, many corporations still deal directly with an FX advisor on a trading desk of a financial institution. The advisors also provide risk management strategies for companies designed to mitigate adverse movements in currency exchange rates. Typically, on the larger trading desks, one or two market makers might be responsible for each currency pair. The Australian dollar dealer might also be responsible for the New Zealand dollar while there might be a separate dealer making quotes for the Canadian dollar.
Forex interbank desks generally deal only in the most popular currency pairs called the majors. Additionally, trading units may have a designated dealer that is responsible for the exotic currencies or exotic currency trades such as the Mexican peso and the South African rand. Just like the forex market comprehensively, the forex interbank market is available 24 hours. How Interbank Pricing is Determined Bank dealers will determine their prices based upon a variety of factors, including the current market rate and the volume available or liquidity at the current price level.
If liquidity is thin, a trader might be reluctant to take on a position in a currency that would be difficult to unwind if something went wrong in the market or with that country. If a trader takes on a position in a thin market, the spread will typically be wider to compensate for the risk of not being able to get out of the position quickly if a negative event occurs. This is why the forex market usually experiences wider bid-ask spreads at certain times of the day and week, such as a Friday afternoon before the U.
An interbank trader also considers the bank's forecast or view on where the currency pair might be headed and their inventory positions. If the dealer believes that the euro is headed higher, for example, they may be willing to offer a more competitive rate to clients who want to sell them euros because the dealer believes that they can hold onto the euro position for a few hours and book an offsetting trade later in the day at a better price—earning a few pips in profit.
The flexible nature of market prices is something that is unique to market makers that do not offer a fixed spread. Deal Platforms and Credit Risk Similar to the way we see prices on an electronic forex broker's platform , there are two primary platforms that interbank traders use: One is offered by Reuters Dealing, and the other is offered by the Electronic Brokerage Service EBS.