The Backend to the Forex Market

The front end of the foreign exchange market is enticing. Investors and speculators see technicolor charting, new indicators, and the opportunity for massive profits. Unfortunately, very few investors understand what happens behind the scenes and how a trade travels from their desktop to the world's largest financial market.

In truth, anywhere you currently exist is right smack in the middle of the forex market. Where the New York Stock Exchange has a central meeting place on Wall Street and commodities a spot in Chicago, the forex market is global. No central location is used to determine market prices, and orders are completed by several different institutions, known as interbanks, at any point around the globe.

From Your Desktop to the Interbank

The interbank forex market is the most wholesale market in all of finance. On this market, which is made up of over 1,000 interconnected banking institutions, trillions of dollars worth of currency trades hands each day. Much of this interest is speculative, some of it is legitimate transfers from one currency to another, and another portion is central bank and government activity.

When a retail trader goes to place an order through their retail broker, the broker then sends the order to the interbank. The interbank with which the broker has a relationship may quote a price with a 2 pip spread, which the broker then increases to 3 pips and offers to the trader. The broker earns a pip on the transaction, and the interbank earns two and holds the position for the trader for the length of the trade.

On the forex market, each trade is essentially a transferred amount of money. To complete a sell order of one lot of GBPUSD, an interbank would borrow $100,000 in GBP, swap it for its value in USD minus the current spread, and hold it in an interest bearing US dollar denominated account. When the trader goes to sell, the trade is reversed, the USD is converted back to GBP, the loan is paid off, and the win or loss is debited or credited to the broker and finally then to the trader.

Interbanking and Big Business

Interbanking on the forex market is big business. If each day just one trillion dollars in speculative interest is generated at a cost of two pips, $200 million dollars in spreads are generated. Obviously, much of the activity on the foreign exchange market is between interbanks who are speculating amongst one another, and they do not assess spreads as a means to generate income. Rather, interbanks that maintain positions on the market generate their investment profits from changes in currency values.

Interbanks play a vital role in establishing a forex market that allows businesses in any country and continent to do business without much regard for currencies. Thanks to interbanks, transaction costs on the forex market are perhaps lower than any other business, with spreads for most pairs equaling less than one fiftieth of a percentage point. Compare that to sales taxes on final goods, or the tariff costs on selling goods in one country that were produced in another.

In more than a few ways, the forex market is the freest and largest market on the face of the planet, and despite its massive size, it is still the most reliable, open 24 hours a day, seven days a week.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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