Forex is by far the largest financial market out there. It outstrips the stock market by a couple of orders of magnitude.
Of course, banks are not going to stay on the sidelines of such a large amount of money. In fact, Forex is largely driven by banks, more specifically central banks!
There is a lot more to Forex than just currency exchange for speculative purposes. And having a good understanding of this can help you be a more profitable FX trader.
Banks are the largest players in the forex world. Sometimes, they have enough power to directly affect the value of currencies.
So, what’s going on?
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Most Forex Trading is Not Forex Trading
Unlike other markets that are driven primarily by investors looking for a financial return by buying (and selling) assets, Forex has a very large practical component to it.
Firstly, the most logical is the need for multinational corporations around the world to pay for goods and services that they buy overseas. Global trade is one of the primary drivers of currency values. Over $5 trillion in products and services are bought and sold around the world and counting.
Bigger than that are banks balancing their holdings, especially central banks. Every time an asset is bought or sold, funds move from one bank account to another.
When, for example, a Saudi oil billionaire decides to buy stock in the US using money in his account in the UK, the banks involved in the operation have to balance their holdings of dollars and pounds.
It’s the Rules
The banks have to maintain a certain amount of assets to comply with regulations. But, when the value of those assets changes because the price of the currency changes, the bank has to buy and sell certain amounts of it to “trim” their assets to meet their balance sheet.
On a much smaller scale, something similar happens when you travel overseas. When you buy souvenirs and food in a foreign currency using your credit card, that starts a chain of transactions.
This chain leads the credit card company, the bank, and depending on the local rules, even the central bank, to balance their currency holdings.
It’s Just the Big Guys
Banks will also trade their clients’ assets at their request. This is why you can get a Forex account in most major banks.
However, they generally are interested only in large transactions. And most banks require initial deposits that are out of range of most budding FX traders.
Hence the existence of retail brokers who allow you to access the Forex markets without having to deal with the often onerous banking regulations.
In the end, though, whether you are trading with a Forex broker or with a bank, the vast majority of trading in the markets is done by banks. They are the ones who are responding to technical and regulatory needs, and not simply speculating on the market.
This causes the Forex market to be more “logical”. It makes it less prone to wide speculatory swings than other asset classes. On the other hand, that means profitability is more down to diligent trading than finding some obscure trick to luck your way into riches.
