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5. Forex Market Participants: The Central Banks
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In our last lesson we looked at how the advent of online trading platforms has begun to level the playing field for individual traders, allowing a much greater access to favorable pricing than was previously available. In today’s lesson we are going to continue our discussion on the structure of the FX market, with a look at who the different players in the market are and how the motives of each affect us as individual traders.
While the 10 largest banks which make up the forex Interbank market account for over 75% of the over $3 Trillion in daily trading volume, there is actually a level of participants with even more clout in the market. While generally no where near as active as the banks just mentioned, the Central Banks of countries also participate in the forex market, and as they have such deep pockets, have huge clout when they decide to enter the market.
There are two main reasons why a central bank would participate in the forex market which are:
1. To fix the value of its currency to a particular level: Unlike the main currencies which we are going to be focusing on in this course, the currencies of many developing countries are fixed in value to the dollar or to some other currency or basket of currencies. This is done to try and promote international competitiveness in the market and a currency environment that is more conducive to economic stability.
Probably the most talked about example of a country that does this is China who up until recently maintained a fixed value of their currency against the US Dollar. A central bank normally accomplishes this by buying their own currency when the value gets too weak creating more demand for the currency and therefore driving the value up, and selling their own currency when it gets to strong creating a greater supply of that currency and therefore lowering its value back to the desired level.
2. To protect the value of a floating currency from extreme movements: Unlike China and many other developing economies in the world, the US, The Euro Zone, Japan and the other major economies of the world have what is known as a floating exchange rate. Very simply what this means is that instead of having the value of the currency pegged to something else which therefore determines its value, the value of the currency is determined by market forces.
Although the values of these currencies float freely in the market most of the time, as a currency’s strength or weakness in the market has such a dramatic affect on a country’s international competitiveness, there are rare instances where a central bank will intervene in the market even with the major currencies. Normally this is only seen after large one directional moves in the market over a long period of time, to the point where the country’s stability or competitiveness is being severely damaged. As Japan’s economy relies heavily on exports the most notorious central bank for interventions is the Bank of Japan, however both the European Central Bank and the Federal Reserve have intervened in the currency markets in the pasts.
While some interventions have limited affect on exchange rates others, as you can see from the chart here of a past Bank of Japan intervention, can have a dramatic affect on the market.
Because of this often times a central bank can do what is termed a verbal intervention, where simply the talk of intervention is enough to have the desired affect on the market.
That’s our lesson for today, In tomorrow’s lesson we will look at the next level of participants in the market and how they affect us as individual traders, so we hope to see you in that lesson.
As always if you have any questions or comments please feel free to leave them in the comments section below, and good luck with your trading!
Last edited by InformedTrades.com; 08-21-2008 at 12:34 PM.
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evaluate a pair ex GPB/JPY
Why GPB was 216 yen in 2008 and now only 131 yen ?
I know you will say supply and demand. Can you tell more specificly which factor has devaluated the pound since 2008 until today. and as also 120 could be the bottom? Thank you
-For me is just looking the chart MA 3 and 5 daily crossing and stochastic to see if a currency is overbought and so on...
But economicly how it works?
why a pound in 2008 has so much power of purchase more than now if an English man brought his 100 pd to Janpan and buy some thing in 2008 and 2009?
what make it different?
do the banks give you notice when they are going to intervene.
They do not. Sometimes their goal is to catch traders off guard. That can create some panic exiting which can really move the market in the central bank's intended direction. If they do announce anything, it is most likely just talk to see if they can convince the market to move in the direction they want.
Originally Posted by nopainnogain
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That makes a lot of sense. Catching traders off guard in order to better the odds. Who would have thought of it. Thanks for the insight.
The new DailyFX Course has nearly 600 minutes of content delivered via video so you can learn at your own pace.It's really good information.
this is an excellent resource....absolutely critical.
thank you man.
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