Market participants and their functions

While on stock markets investors only trade with institutional investors (like mutual funds), on Forex market there are more parties that trade and it is very important for all participants to understand the functions and reasons of those players. And here we talk about governments, central banks, financial institutions, speculators and hedgers.

Governments and Central Banks are for sure the most influential participants in the Forex market. In most of the countries, the Central Bank appears as an extension of the Government and it acts according to its policy. On the other side, some governments grant more independence to the central banks, considering that this increases its efficiency in managing inflation and keeping interest rates low, which increases economic growth. Central banks are usually involved in maintaining foreign reserve volumes in order to reach some economic purposes, so they use the foreign exchange markets to adjust these reserves. Since they own abundant financial resources, they have a significant impact on currency markets.

Financial Institutions and Banks are also involved in Forex market, through small-scale transactions (usually made with individuals) and currency transactions (between banks, known as the interbank market). The larger banks usually have more credit relationships, so they receive better foreign exchange prices. So banks act as dealers by buying or selling a currency at the bid/ask prices. And they make money on Forex by exchanging currency at a higher price that they paid to obtain it.

Speculators are another category of participants on Forex and they make money by taking advantage of fluctuating levels of exchange rates. Speculators can have a big impact on the Forex market since they can affect a country’s currency and economy. A good example in this category are the hedge funds, known as unregulated mutual funds that use unconventional and very risky strategies to make very large returns.

Hedgers are often employed by international businesses which are selling to international clients or are buying from international suppliers. In both cases, they will have to face the volatility of fluctuating currencies and the solution here are the hedging strategies in order to lock in a specific exchange rate for the future. This way, all the risks of the exchange rate are removed from the transaction.

All those participants in Forex have significant impact on countries currencies and for traders, it is important to know the role of each player. Making some research about central banks policies and the functions of the other financial institutions will be really helpful when starting the trades.