Forex Market Structure

An example may make it less hard to understand this thing we’re calling the “Interbank” market. In most larger offices or business, perhaps even in your own home, there may be several computers which are inter-connected by means of a simple network cable. Now, each computer operates independently until the moment it needs a resource, program or file from one of the other computers. When that happens, computer A will contact computer B (or C or D, etc.) & request permission to access the needed resource. If the owner or operator of computer B authorizes it, & if computer B is functioning the way it should be, then the needed file or program can be accessed. Within minutes, computer A’s request is fulfilled. It works the same way in the forex market; substitute computer A & computer B for Bank A & Bank B & let resources substitute for currency. You now have the machinations for the relationships that exist within the Interbank process.

At the top of the forex market are transactions which are collectively called Interbank transactions. The “Interbank” is not, as some people may believe, an exchange. , it is a collection or compilation of agreements between & among the major currency center banks in the world.

In a way, the EBS service acts as a blanket over the Interbank communication links. Through the EBS service, Interbank members are able to see how much currency is available, & the price(s) the other Interbank participants are willing to pay. It’s important to understand that the EBS is not in itself a market nor is it a market maker. The EBS technique is merely an application allowing bank members to see offers & bids from the other members.

By the same context, if you’ve ever tried to locate resources from a computer that isn’t united by a computer network, you probably know full well what a time consuming, inefficient, sometimes futile effort it can be. you have to search each & every independent computer until you’ve found your resource, copy it & then download it to your own computer. Regarding prices & forex currency inventory, the same issue exists within the Interbank market process. If a bank in Taiwan occasionally transacts business with a firm in Sao Paula they need to exchange their currency. In this case, it can be difficult to determine what the proper exchange rate between the New Taiwan Dollar & the Brazilian Real should be. Because of situations such as this, the Electronic Broking Service (EBS) & Reuters established their services. For simplicity, we’ll refer to this service as ESB.

The third tier is the retail market. Established foreign exchange brokers such as Forex.com, Oanda & FXCM, etc. or any broker who wishes to set up a retail operation, needs first to find a liquidity provider. The large majority of these forex brokers sign an agreement with a single bank. This bank agrees to provide liquidity only under certain conditions: That is only if they can simultaneously hedge it on EBS, including their desired spread.

The forex market’s second tier essentially exists within each individual bank. If you were to call your local Citibank branch, they can arrange for you to exchange your U.S. Dollar for the foreign currency of your choosing. In all probability, they will likely move the desired currency from one bank branch to another one. This is known as a single party micro-exchange, so you are much at their mercy as it applies to the foreign exchange rate you’re quoted. You can either accept their “kind” offer or shop around for a better rate. someone who trades in the forex market should consider paying their bank a visit, at least two times, to have an idea of their quotes. Certainly, it will be “enlightening,” if not downright shocking, to see how profitable these transactions are… for your bank.

These spreads will be highly competitive, & that is because that volume will be much greater than any single bank patron would ever transact. Bear in mind, banks are in the business to make funds, & third tier providers will seldom precisely match what actually exists on the Interbank process. Banks collect the spreads & no agreement between them & a forex retailer is going to fine-tune their priority.

Think of retail forex as a kind of casino. Most of the participants have little or no knowledge of forex trading effectively or successfully and, as expected, they’re consistent losers. The forex broker has the house advantage because of the inherent spread technique & the normal probability distribution of returns. What results, is a technique that plays one loser against one winner & collects the spread. If there's a dis-equilibrium within their internal order book, a broker may hedge the exposure with their second tier liquidity provider.

An ECN or Electronic Communications Network operates similarly to a second tier bank, but it exists, , on the third tier. The ECN generally will establish a liquidity agreement with over one second tier bank. Instead of internally matching the book orders, it passes the quotes through from the banks, as they are, to be traded. You might look at it as an EBS, of sorts, intended for the little guys. While there may be several advantages to the model, it still isn’t the Interbank.


Though it may not sound nice, there's significant advantages to the speculators that work with them. Since it is “internal,” plenty of features, such as high leverage on an account with only a small balance, a non-standard contract size, & commission-free transactions can be provided which may not be available through any other means.