Do you know What is the global Forex market, Part-3

Types of exchange rate systems

An exchange can operate under one of four main types of exchange rate

systems:

Fully fixed exchange rates

In a fixed exchange rate system, the government (or the central bank acting

on its behalf) intervenes in the currency market in order to keep the exchange

rate close to a fixed target. It is committed to a single fixed exchange rate

and does not allow major fluctuations from this central rate.

Semi-fixed exchange rates

Currency can move within a permitted range, but the exchange rate is the

dominant target of economic policy-making.  Interest rates are set to meet

the target exchange rate.

Free floating

The value of the currency is determined solely by supply and demand in the

foreign exchange market. Consequently, trade flows and capital flows are the

main factors affecting the exchange rate.

The definition of a floating exchange rate system is a monetary system in

which exchange rates are allowed to move due to market forces without

intervention by national governments.  The Bank of England, for example,

does not actively intervene in the currency markets to achieve a desired

exchange rate level.

With floating exchange rates, changes in market supply and demand cause a

currency to change in value. Pure free floating exchange rates are rare - most

governments at one time or another seek to “manage” the value of their

currency through changes in interest rates and other means of controls.

Managed floating exchange rates

Most governments engage in managed floating systems, if not part of a fixed

exchange rate system.

The advantages of fixed exchange rates

Fixed rates provide greater certainty for exporters and importers and, under

normal circumstances, there is less speculative activity - though this depends

on whether dealers in foreign exchange markets regard a given fixed

exchange rate as appropriate and credible.

The advantages of floating exchange rates

Fluctuations in the exchange rate can provide an automatic adjustment for

countries with a large balance of payments deficit. A second key advantage of

floating exchange rates is that it allows the government/monetary authority

flexibility in determining interest rates as they do not need to be used to

influence the exchange rate.

The EUR-USD has dropped? So w

hat!

(you can profit in any direction it takes, provided you chose the winning direction…)

Who are the participants in today’s Forex market?

In general, there are two main groups in the Forex marketplace:

Hedgers

account for less than 5% of the market, but are the key reason

futures and other such financial instruments exist.  The group using these

hedging tools is primarily businesses and other organizations participating in

international trade.  Their goal is to diminish or neutralize the impact of

currency fluctuations.

Speculators

account for more than 95% of the market.

This group includes private individuals and corporations, public entities,

banks, etc. They participate in the Forex market in order to create profit,

taking advantage of the fluctuations of interest rates and exchange rates.

The activity of this group is responsible for the high liquidity of the Forex

market. They conduct their trading by using leveraged investing, making it a

financially efficient source for earning.

Market making

Since most Forex deals are made by (individual and organizational) traders, in

conjunction with market makers, it’s important to understand the role of the

market maker in the Forex industry.

Questions and answers about 'market making'

What is a market maker?

A

market maker

is the counterpart to the client. The Market Maker does not

operate as an intermediary or trustee. A Market Maker performs the hedging

of its clients' positions according to its policy, which includes offsetting

various clients' positions, and hedging via liquidity providers (banks) and its

equity capital, at its discretion.

Who are the market makers in the Forex industry?

Banks, for example, or trading platforms (such as

Easy-Forex™

), who buy and

sell financial instruments “make the market”. That is contrary to

intermediaries, which represent clients, basing their income on commission.

Do market makers go against a client's position?

By definition, a market maker is the counterpart to all its clients' positions,

and always offers a two-sided quote (two rates: BUY and SELL). Therefore,

there is nothing personal between the market maker and the customer.

Generally, market makers regard all of the positions of their clients as a

whole. They offset between clients' opposite positions, and hedge their net

exposure according to their risk management policies and the guidelines of

regulatory authorities.