This is the structure of the Foreign Exchange (FX) market that traders must know

The structure of the forex market is different from other financial markets. This special character must be known by traders.

Foreign Exchange trades, also known as forex, is often considered the most profitable financial market.

One factor that indicates this is the forex market's daily liquidity reached USD 5.3 trillion in 2013 alone. Yields are certainly better than other financial markets with lower liquidity such as stocks.

In addition to the many potential profits, investing in the forex market also has advantages in terms of lack of capital and flexibility in being able to trade anywhere, anytime.

However, rarely do you understand the structure of the real forex market and how we are positioned as small traders in this market.

Basically, the Forex Market is a decentralized global market where all world currencies are traded, and traders generate profits or losses from changes in currency values.

Perpetrators of buying and selling in this market include various groups, including the Government, Banks and Financial Institutions, Multinational Companies, Speculators, Brokers, and Forex traders from among the common people. 

However, even though all forex trading players do not have the ability to determine prices, not all actors are equal.

Why is that? This is because the structure of the forex market is not centralized, unlike the centralized stock market.

Centralized stock trading, meaning all seller and buyer activities are centered on the stock exchange. Companies as stock issuers and investors as buyers are brought together by the stock exchange.

Although today's stock trading has been done online, the system is still centralized on the exchange. However, forex trading does not have such a center and takes place outside the market (Over The Counter/OTC).

Forex is different from the stock market or futures market where forex does not have a central point like a stock exchange or futures exchange.

So the forex structure is commonly called the "over the counter (OTC)" market without having a regulator or processing center, like the internet globally, where all FOREX trading is electronic open 24 hours for 5 working days connecting all Forex market participants.

But make no mistake, even though you have a transaction at one of the brokers, you may not be able to get direct access to the Federal Reserve, because you have to go through big banks.

Every forex market player makes transactions with each other directly or through brokers and banks, without the mediation of certain exchanges.

At a glance, the structure of the forex market that is not centralized seems messy, but in fact the players of forex trading can be described in a certain hierarchy.

In the Forex Market hierarchy, the top boxes are occupied by networks formed by major bank transactions, called interbank.

The major banks are Citi, Goldman Sachs, HSBC, Morgan Stanley, JP Morgan Chase, UBS, Deutsche Bank, Barclays, etc.

The Interbank network consists of the world's central banks, major banks, and several smaller banks. They all trade directly with each other or electronically via Electronic Brokering Services (EBS) or Reuters Dealing 3000-Spot Matching.

On the EBS platform, the EUR/USD, EUR/JPY, EUR/CHF, USD/JPY and USD/CHF currency pairs are more liquid.

While on the Reuters platform, the currency pairs AUD/USD, EUR/GBP, GBP/USD, NZD/USD and USD/CAD are more liquid.

After passing through several institutions such as retail broker Market Maker, ECN retail broker and Hedge Funds, then the bottom line is retail traders like us.

Retail traders like us seem to be grateful to the internet, electronic trading technology, and retail bro, because thanks to them we can take advantage of this huge market.

Forex structures that have legal agreements nationally and internationally can be summarized as follow:

  • Markets are spread all over the world without a control center that processes prices.
  • Individual level is enough with transactions at money changers or small banks, although sometimes individuals can directly make transactions to large banks because the rich will invest large amounts of money in the forex market.
  • The first level is Forex Brokers who forward customers' orders to large banks
  • The Second Level is Small Banks that are connected to the Large Banks in the country and even abroad, also directly to their respective Central Banks.
  • The Second Level is also the Big banks, each of which is connected worldwide including the National Central Bank.
  • The Third Level is National Central Banks throughout the world that are connected to each other.

Although forex trading is done all over the world, but the prices that appear on the broker can be the same or almost the same, this happens because the main transaction volume comes from the Central Bank, then forwarded to large banks, then to small banks and so on to the brokers where you trade.

These prices are what you can find on the Forex MT4/MT5 platform, because the split-second electronic transfer system prices are not much different between prices at central banks, large banks, small banks and brokers.

The prices of the Bank are seen in the Bid and Ask with spreads depending on the beginning to the end of the broker, but for large banks it can be a transaction without spread because the volume is very large compared to the spread between the Bid and Ask prices which are usually carried out against the currency main.

Electric Communication Network on the Forex market known as ECN serves as an electronic server to match the orders of the Buy and Sell forex participants with the same amount and volume.

If there is a volume that does not have an offer, then it will be shown to other participants by including the ECN as a counter, generally the data of the buyer and seller must be anonymous. The top ECN at the moment is Nasdaq.

Besides ECN, there is also software that is used to transact over the Reuters Dealing trading platform which currently competes with Electronic Brokering Services (EBS). Besides that there is also a terminal like this, namely Bloomberg Tradebook.

Now, to transact directly using this platform, you have to spend $3,000 per month. So it doesn't need to use this tool because actually through a broker it's quite comfortable.

Currently, the largest ECN broker is held by Matchbook FX, which has direct connections to large banks such as Goldman Sachs, UBS, Citibank and others.

The highest forex market participant is held by JPMorgan of the Big 10 banks based on data from "Euromoney FX Survey 2018 - press release", but there are three companies that can maintain their position since 2017 namely Deutsche Bank down one rank and XTX Markets jumping from 12th rank to 3rd place.

Overall, the market share of the top five banks fell to 40.09%, from the previous data at 41.05% in 2017. There are currently six non-bank liquidity providers from the top 50 companies compared to only seven in 2017.

Forex is an interbank market. If there is a small or large spread, the banks have several reasons, because these banks can usually transact without using spreads because the trading volume is very large.

There are also large types of participants in the forex market, usually commercial companies or multinational companies.

Transactions of companies like this can even increase double in the forex market. Other participants in the forex market such as central banks, for example the ECB, the Bank of Japan or the Fed Reserve, also actively take part in the Forex market for the benefit of their own countries, for example international government payments, foreign exchange transactions or other processes.

In addition to banks that have large forex market shares, they are also controlled by hedge funds, because basically the forex market with transactions of 70-90% is always speculative. And finally the forex market participants are Retail Brokers and and you as a retail trader.

The forex market structure may indeed seem a mess, but that is what makes forex trading a business other than others. When trading in the giant market alias, our mainstay will be the sharpness of our own analysis in deciding prices carefully, at the right time.