The Forex market is one where currency trading takes place and its purpose is to facilitate trade and investment. The foreign exchange (Forex or FX) market is an over-the-counter (OTC) market. This means that it does not have a central exchange or clearing house that matches orders. There is no single exchange where all the trades are recorded. Instead, every market maker records its own transactions. The FX market is a means for companies to hedge currency risk, or to protect themselves against volatility in currency values.
The primary market makers in the currency markets, who make bid and ask spreads, are the largest banks in the world. These banks deal with each other on a constant basis, via the Electronic Brokerage System (EBS), on behalf of their customers or themselves. Banks make their quotations available in this market to only those banks with which they trade and this market is not accessible to individual investors. The stiff competition between banks ensures fair pricing and tight spreads.
Although retail investors are not involved in the Interbank market, it is critical to understand the functioning of one, so as to determine that a broker is offering fair prices and to gain a better understanding of the pricing of retail spreads.
The factors that currency dealers consider to determine prices include volume available at the current price level, the current market rate, their account positions and their opinions on the direction of a specific currency pair. For example, if a bank dealer opines that the US dollar is likely to decline, they reduce the price at which they are willing to purchase dollars.
Retail traders may access the FX market via online market makers that trade largely from the US and the UK. These market makers have a relationship with a number of banks on an EBS. Higher the trading volume of a market maker, greater the likelihood of it having an association with a larger number of banks and, consequently, more competitive are the quotations. Thus, it is extremely important for an individual investors to conduct an extensive analysis of a forex broker before making a choice.
The primary difference between the Forex and other markets is that there is no data available that specifies the volume that is being traded at any given time or at a particular price.