To understand what happens when a trader places a forex trade, it is essential to understand the structure of the forex market. The broad framework is that there are three tiers to the forex market: the Interbank market; large retail banks and funds; and the newest class, retail foreign exchange firms. Below is a breakdown of each tier, and how they interact with the other tiers to create the overall structure of the forex market.
Interbank Market. The Interbank market consists of the largest banks and central banks. These banks trade with each other via a system known as EBS. EBS is simply a software application that shows each banks resources, and thus helps Interbank participants understand supply and demand so that they can develop fair prices to trade with each other.
Retail Banks. The next tier consists largely of retail banks (e.g. Chase Manhattan, Bank of America, etc). When individuals exchange their currency with such banks, the banks often simply move currency around from one branch to another. They profit by charging a spread -- a different price for buying than for selling (so that if you buy a currency and look to sell it right away, you do so at a loss). In the event that retail banks need more of a given currency, they go to the tier above them -- the Interbank market.
Retail Forex Brokers. The newest tier consists of retail foreign exchange brokers. These foreign exchange brokers allow individual traders to speculate in the forex market in real time -- much like how interbank participants operate. These forex brokers typically have relationships with retail or Interbank market participants with whom they offset their orders. In other words, they take prices from the banks they have relationships with, add a markup, and then give this new price to retail traders. Many forex brokers also opt to match orders internally, meaning they match up buy and sell orders from their own clients, and only offset with the banks they have relationships with when they need to.
This is the three-tiered structure of the forex market, and is the basic framework through which virtually all foreign exchange transactions go through.
Simon Parth has been an active forex trader since 2002. He is the co-founder of InformedTrades.com, a community dedicated to creating a comprehensive free online school for traders.
Interbank Market. The Interbank market consists of the largest banks and central banks. These banks trade with each other via a system known as EBS. EBS is simply a software application that shows each banks resources, and thus helps Interbank participants understand supply and demand so that they can develop fair prices to trade with each other.
Retail Banks. The next tier consists largely of retail banks (e.g. Chase Manhattan, Bank of America, etc). When individuals exchange their currency with such banks, the banks often simply move currency around from one branch to another. They profit by charging a spread -- a different price for buying than for selling (so that if you buy a currency and look to sell it right away, you do so at a loss). In the event that retail banks need more of a given currency, they go to the tier above them -- the Interbank market.
Retail Forex Brokers. The newest tier consists of retail foreign exchange brokers. These foreign exchange brokers allow individual traders to speculate in the forex market in real time -- much like how interbank participants operate. These forex brokers typically have relationships with retail or Interbank market participants with whom they offset their orders. In other words, they take prices from the banks they have relationships with, add a markup, and then give this new price to retail traders. Many forex brokers also opt to match orders internally, meaning they match up buy and sell orders from their own clients, and only offset with the banks they have relationships with when they need to.
This is the three-tiered structure of the forex market, and is the basic framework through which virtually all foreign exchange transactions go through.
Simon Parth has been an active forex trader since 2002. He is the co-founder of InformedTrades.com, a community dedicated to creating a comprehensive free online school for traders.
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