Where did it all start?

[sarrafx]

In the past trading fx was purely the domain of banks and financial institutions. They derived a significant part of their income from interbank fx.

Banks have always been the facilitators of currency exchange and were involved from two very distinct angles and this involvement determined their status as either market makers of market users or takers.

Take first of all market makers. They undertook to quote a price to "the market" usually on a reciprocal basis at a given spread determined by size of transaction. On a reciprocal basis meant Bank A would quote Bank B provided Bank B undertook to quote Bank A on the same terms. Market makers would quote the market according to their book. That is to say if they were "long" Gbp/Usd they would quote a marginally lower price to the market if asked as they may not want to buy more or want to make their offer to sell slightly more attractive. They would also "read" the market and if there was a lot of selling going through they would also mark their price down.

In the past there were many more market makers but that number dwindled as technology investment sped up.

Market takers were banks who had some client fx trading but didn't want or have the volume to justify quoting fx rates to the market.

They would contact market makers and ask for a specific price for a specific transaction (usually backed by a client transaction). The market maker would make a slightly higher spread as there was no reciprocation in pricing.

The fx market is jsut about the least regulated market in the world but that is changing following the financial crisis of 2008. There is a great deal of opinion as to how much regulation is required but it is certain that self regulation is no longer an option. Pricing for fx is simply supply and demand. The size of the market ensures that liquidity is always very high and there are no opportunities for anyone to "corner the market" i.e drive prices higher or lower to suit their own requirements.

In the past ten to fifteen years the fx market has been taken over by the use of technology. Pricing has become infinitely faster, spreads have narrowed to such a degree that where the majority of currencies quoted in interbank fx used to be quoted to four decimal places, they are now quoted to five! so Gbp/Usd used to be for example 1.5425/1.5430 it is now 1.54255/1.54257 on interbank screens.

This has led to the growth of the retail fx market and the advent of fx margin trading where day traders can make money online from home.

FX margin trading has been created where you trade fx and place a margin with a broker to cover any losses. As the margin is only covering potential losses, it can be leveraged to make the size of the trades quite substantial in comparison to the size of the margin.

For example a client places $10,000 with a broker to trade fx. The broker gives him access to an fx economic calendar so that he can understand what influences there will be on the market from data releases (e.g. unemployment or foreign trade) and also access to some forex trading technical analysis. He will be provided with a platform where he can see live exchange rates.

As an example, suppose that the broker allows him to leverage his $10,000 by a factor of 100:1. that is to say he can have outstanding trades to a value of 100 times his $ 10,000 or $ 1,000,000 (one million).

In his first trade he buys GBP 250,000 vs USD @ 1.5420 (equivalent to $385,500). Every one pip move (1.5420 to 1.5421 or 1.5419) is a profit or loss of $25. So the market has to go down (remember he bought) by 400 points for him to lose all his margin. Equally though if the market rises by 400 points he doubles his money.

The ability to trade in this manner for a retail investor has been brought about by the advances in technology spawned by the internet.