What is the FX market, what’s it for, who benefits, how can you trade it, how can you attempt to profit from it? If you converse with other FX traders, either face to face or online, you quickly begin to realise that the vast majority of retail traders have very little understanding of the underlying foundations, which underpin the forex market. Moreover, they make very little attempt to discover what factors actually cause the creation of the complete FX market.
Retail FX traders often fail to look past the information on their screens; they apply no inquisitive thinking or intellectual curiosity, with regards to how the FX market exists, or who it really exists for. You could argue that such knowledge is superfluous, you only need to concentrate on the data immediately in front of you, to make judicious trading decisions; “who cares what institutional traders are trading, or who they’re trading for, it doesn’t affect my bottom line does it?” This is lazy thinking, because unless you understand the forex market; who moves it, who the major players are and why price moves, then your lack of market knowledge will always compromise and hamper your progress.
To understand the forex market you firstly have to recognise the place retail FX trading occupies in the overall scheme, of the circa $5.2 trillion a trading day turnover business. Estimates from various sources, such as BIS (bank of international settlements) and various FX broker associations and finance authorities, calculate that retail trading accounts for less than 10% of that turnover. Therefore, it’s safe to assume that retail FX trading, despite being a significant constituent part of the numbers, doesn’t move the market. It’s highly unlikely that a retail trader, or a broker placing its cumulative client bets/orders, can ever have an impact on price.
The bulk of FX trading, some estimates putting it at circa 85%, is conducted by large institutions, placing their orders for their corporate clients. These banking institutions will be mainly acting for clients such as exporters or importers. Who are attempting (through the bank’s brokers), to use the FX markets to fix prices for their costs, by way of simple, break even, hedging strategies. They do this in order to smooth out fluctuations in currency movements. An example could be a car manufacturer, based in the E.U. exporting to the USA. If the U.S. dollar rises by 10% in a year, theoretically a lower euro should be good for the E.U. firm as an exporter, there’ll be more demand from the USA.
But if the situation reverses the manufacturing exporter could find itself on the end of a significant loss. Moreover, in our just in time, global economic environment and models, the manufacturing firm with the weaker domestic euro, will have to be extremely careful buying their imported parts to manufacture the finished product. If they get the pricing wrong, due to fluctuations in the value of the euro, the losses on the currency trades could severely impact on the firm’s bottom line.
So what does this have to do with the prices and quotes retail FX traders see on their screens, how can it impact on your trading? Surely it’s irrelevant? Well no, it isn’t irrelevant, it’s highly relevant, when you apply some critical thinking to the subject.
It’s worth contemplating what the average trading range of a major FX pair is on any given trading day, versus the equivalent movement of an equity. If an FX pair moves by 1% in either direction during a trading day, that’s considered to be a considerable move. It would also be a considerable range if a major pair traded in a whipsawing manner, of circa 1% in the day. This is proof that our FX markets are actually ‘quieter’ and less volatile than many other markets. If you compare and contrast this to other markets, it’s quite a revelation.
Certain FANG stocks, on the U.S. NASDAQ, might have daily ranges of 5%, certain commodities are also often subject to wild swings in value. Quite frankly, if our FX markets reacted in similar manners and generated similar price action to certain equities, they’d be largely impossible to trade and global commerce would grind to halt. As the largest known trading market, that massive $5.2 trillion a day turnover, creates a form of predictability that is quite unique to our FX markets.
Here’s one other aspect of how our FX market at institutional level is directly linked to your retail FX trading and your potential decision making. Consider for a moment where an FX trader, at a massive investment bank, may place their order (of considerable size) for their clients. Do you think they’re hunched over their screens, making decisions off five minute charts, using a technical indicator based strategy based on: MACD, RSI, PASR, ADX, DMI, waiting for the readings to converge? Or do you think they may make their decisions off: daily, weekly and monthly charts? Would they look at round numbers (handles) large DMAs, such as the 100 and 200, and perhaps analyse daily activity, by way of pivot point levels? It’s fairly obvious that they’re going to buy and sell currency for their clients, using larger reference points.
These large, institutional level traders, who could be accountable for up to 85% of FX turnover, do have one common and shared interest with retail traders; the economic calendar is used by traders at both ends of the the spectrum, to make decisions from.
To conclude, it’s now apparent; who moves the FX markets, why they move, when they move and by how much. This also illustrates why it’s essential that retail traders engage in self education to become fully aware and tuned in to the behaviour of the largest trading market ever created, the forex market.
