written by: William Springer•edited by: Jason C. Chavis•updated: 11/30/2010
How much do big banks trade in the forex market and what are the implications for the individual investor?
slide 1 of 4
The Big Boys of FOREX
From reading many financial sites, you might get the idea that it's very easy to make money in Forex (the foreign exchange market); I'm sorry to tell you that this is not true. One reason for this is that you're competing against some major players: governments and central banks. How much do big banks trade in the forex market? Well, daily turnover is currently in the area of $4 trillion per day, and commercial banks make up approximately half of that. In short: there's a lot of money moving around! While it's certainly possible to beat the banks in the forex markets, it's definitely not easy!
slide 2 of 4
Why Banks Trade
Central banks often use the forex markets in an attempt to control the money supply, driving their own currencies towards preset target rates and using their foreign reserves to stabilize the market.
For most banks, however, the majority of trading is speculative; a large bank might trade billions of dollars per day, buying and selling the same currencies and making money off of the price difference, which is called the pip spread. PIP stands for price interest point and is the smallest amount that the value of a currency can change; this is generally the fourth decimal place.
Banks set a bid price (what they will pay for a currency) and an ask price (what they'll sell it for). A bank selling to smaller traders may have a five pip spread between the two prices, while a credit card company may charge several hundred pips. Trades between major banks, on the other hand, may have a spread of less than a single pip.
slide 3 of 4
Beating Big Banks and the Forex Market Trade
The forex trading market is fairly decentralized; trading takes place around the clock, and is open to anyone. It's difficult to make money in forex because there are a number of players who have a lot of money involved and can make trades almost instantaneously in response to changing conditions.Additionally, buying currencies in the volumes required to obtain the best rates requires a volume that is significantly out of reach of the average investor. Remember the question we asked above, how much do big banks trade in the forex market? The number is measured in trillions of dollars per day, where a single bank may be making trades worth billions of dollars. Is this who you want to directly compete with?
Fortunately, there's another way to get involved with currency trading. While the big banks make their money off of the pip spread, individual investors can make money if they can successfully predict how currency prices will change in the future based on political events. Like beating the stock market, this is difficult because it requires finding information that has not been correctly taken into account in the current prices. Futures contracts allow you to lock in a price today for a trade that will be executed weeks, months, or even years in the future, allowing you to lock in a profit (or loss!) if you can find a long-term trend that will result in significantly altering the relative value of two currencies.
Forex trading can be particularly dangerous due to the use of leverage. When a margin account is opened with a forex broker, the broker generally extends a loan to the trader to use in taking positions; this loan can be 100 times the size of the deposit (or even more). As a result, a leverage rate of 100:1 allows someone to trade $100,000 worth of currency by investing only $1,000. You're responsible for the profit or loss on the entire amount invested, not just what you put up; if you use your $1,000 to invest $100,000 and the currency goes up 5%, your profit is five grand - five times what you put in! This is useful because the price of currencies generally changes only by a very small amount each day; however, it also makes it possible to lose much more than the amount deposited - so be careful!