The Players

Since FX prices are shaped by customer flows, in order to fully understand what makes the market lick we need to understand the players involved and their moti¬vations. Although over half of all FX turnover is handled by the interbank market (essentially banks trading with each other) this percentage has been rapidly shrink¬ing (it accounted for two-thirds of all trading 10 years ago) due to the increased participation of sophisticated and varied investors. Where FX was once solely the domain of global banks, nowadays a growing number of speculators such as hedge funds and eTAs actively jostle for space alongside the more traditional players.
In a way, it seems only filling that the largest market in the world should also have the most varied group of panicipants, and everybody from the hedge fund crowd to the frequent flier crowd now has an interest in foreign exchange rates. In order to simplify things, we can divide the FX market into the four major types of panicipams: marker makers, corporate accoums, speculawrs, and central banks.
MARKET MAKERS (Dealers)
In contrast to the other FX participants, market makers are lhe only nOllcustomers in the market and are there instead to provide a service to paying clients. Banks are the only ones with deep-enough pockets to handle the biggest of FX transactions. from billion dollar M&A flows to structured products for corporate clients, but since not everyone can trade directly with a bank specialist brokerage houses have long existed to handle the "leftovers". Unlike bank dealers, whose primary purpose is to m.ake markets for their corporate cl ient base, a dealer for an FX brokerage should playa blind third-party role by simply matching up the orders of their wide customer base and collecting a spread for their trouble (much like a specialist on the NYSE). Speculators can use them to gain anonymity while trading, prop desks may lise them for arbitrage, and individuals may use them because of their smaller size.

Although a dealer's role in the market shou ld theoretically be limited to providing liquidity for their clients, in reality much more is expected of i.I good dealer. and an FX desk is expected 10 generate substantial "off-the-books" prallts for the company by actively trading against their client basco
CORPORATES
Multinationals are the bread-and-butter of the FX world and arc, by and large, seen as the most logical participants in the foreign exchange market. Along with insur¬ance and pension funds. they are known as "real money" accounts as opposed to the leveraged crowd, which borrows substantial amoullls (0 trade. The Coca-Colas and GEs of the world receive and make payments all over the world. which neces¬sitates their involvement in the foreign exchange market. These corporate nows need to be carefully predicted and hedged in advance so that accurate budgets and projections may be created. Since corporate clients are not a particularly SpeCll¬lative bunch, they arc primarily interested in hedging flows through the forward market. For them. the less volatility, the better.
A well-run and pro-active treasury can have a tremendous impact on a company's bottom line, as in the case of BMW, which successrully avoided being hurt by a 13 % rise in the value of the euro against the dollar in 2003 -unlike rival Volkswagen, which had to take a €400 million hit because of bad hedging decisions.
SPECULATORS (Hedge Funds, CTAs, Prop Desks, COMs)
Speculative traders come in all shapes and sizes and tend to be the most interesting bunch in the FX world. Their primary aim is to generate prolits through their views on the markel, as opposed to simply collecting transaction fees (brokers) or using FX as a means to an end (corporates). The big players in this group include prop desks (banks trading their own proprietary accounts), hedge funds. commodity trading advisors (eTAs), and currency overlay managers (COMs). These traders have an appetite for risk and a put-your-money-where-your-mouth-is mentality. but their use of leverage also means that they are more prone to "blowing-up" than other participants. Along with dealers. they are responsible for the majority of intra-day moves.
CENTRAL BANKS
The central banks of the world act as the administrators of the FX market. Each national bank is responsible for their currency. and it is nO secret that they often play active roles "nudging" the market in their preferred direction. Central banks are loathe to see their currency being used for speculation. and although their primary aim in the FX world is to reduce harmful volatility, if fundamental imbalances exist they will sooner or later be refieclCd in the exchange rate. Since CBs love to sec speculators get hurt. interventions in the market are made at strategic moments to catch the market off-guard, and smaller countries may choose to close the doors to speculators altogether by limiting capital flows.
THE FOOD CHAIN
FX participants are arranged in a certain pecking order that ensures that the lOp rung always feeds on the bottom dwellers. In this world, the bottom rung of the food pyramid is occupied by the "public", usually customers whose field of expertise lies olltside trading currencies (corporates) or unsophisticated market participants (retail). Since everybody feeds off the public (especially banks and brokers) this is not where you want to be, and if you are a retail trader paying a 5 pip spread for a 20 pip trade then you immediately fall into this category.
Hedge funds and other sophisticated speculators, on the other hand, are at the top of this food chain, Due LO their speed and market insights, these advanced players are able to prey on banks and brokers that are more concerned with collecting spreads than identifying arbitrage opportunities, It's a speculator's duty to take some of the bank's risk-free profits and pocket them for themselves.

Because a player's positioning on the food chain is dictated by their level of infor¬mation and speed, retail investors unfortunately often have a hard time overcoming the disadvantages that keep them at the level of the "public",
THE ROLE OF THE SMALL SPECULATOR
Small speculators occupy a very peculiar position in the FX world, and often find themselves at the boltom of the food pyramid being preyed upon by more experienced players. Although the odds are stacked against them, some retail traders do, however, manage to overcome the odds with a mix of confidence and sk ill that any bank trader would envy. Such is the story of Yukiko Ikebe, a 59-year-old housewife in Tokyo who was recently indicted for evading income taxes from her roughly 400 million yen trading profits, a story that inspired the head of foreign exchange at Soci~le Generale in Tokyo to proclaim: "She must have made more than us! Find her and hire her!" These outstanding individuals have learned not to " fight" the market. because the market is certainly not fighting them. so they instead focus their altention on taking whatever the market is willing 10 give them, and going by Mrs Ikebe's example it is apparently quite a JOl!
Unfortunately these bright Slars seem to be few and far between, since the vast majority of retail spot FX traders are just not very good in the long run. After all, if market makers profit by trading against their client basco then their client base must be wrong most of the time for them to make money. Retail traders in any market make great contrarian indicators. and their positioning is in fact a valued commodity that is actively traded upon by many funds and money managers. Although you may think their chances of success are 50150, somehow amateur traders have the innate ability to pick tops and bottoms and consistently get chewed up by the market because of their misguided trading decisions and lax money management rules. On the back of the great news, Creative's stock gapped higher the next day and traded as high as 7.60, having closed around 6.00 the previous day. The volume traded was almost len times the daily average, indicating large retail participation. Dealers were well aware of the news, but maybe surprisingly they begin to sell soon after the opening bell (they were selling while the masses were buying). Why did Lhey choose La go against the lide? If you look at the bigger picture you soon realize that although $100 million may be a nice chunk of change, it will in no way alter the prevailing trend -i.e. the iPod will continue to dominate the market. If the lawsuil had changed the fundamentals of the industry (forcing Apple to stop producing their product, for example) then their reaction would probably have been different, but in this scenario they were happy to sell all day long to the unsuspecting buyers and finish the day with a healthy profit when the buying subsides and the price returns to its pre-news level.