UNITED STATES—Currency traders, or more commonly known as forex traders are usually depicted as wealthy individuals sitting in front of dozens of monitors looking at charts all day. It’s safe to say that it’s accurate in the majority of cases. You see, the wealthiest or the biggest forex traders are not the ones sitting at these computers or at home, but banks where you store your money, the retail store where you buy your groceries, the car dealership that you just bought a car from.
Most companies that we see and don’t think too much of, are the biggest players in the currency trading market. This is especially true for banks, who we’re going to focus on in this particular article.
Banks and forex
In most cases, the majority of income that banks generate comes from the interest rate they charge on loans or even account fees. Considering that most banks have millions of customers, it’s easy to justify the billions they get as revenue.
However, in extreme situations, there could be a very big issue in the equity that a bank has compared to what they have promised their customers in interest rates for savings accounts. There have probably been more than enough cases when people wanted to withdraw their savings, and they couldn’t because the bank didn’t have enough equity.
For these reasons banks always look for an alternative source of income as interest rate charges are always tied to the end or beginning of the month. Here’s where forex comes into play.
Difference between banks and forex companies
Imagine you are a bank and have $1 million available as “disposable income”. Most banks in this case would avoid investments in new offices or monthly bonuses so to speak and would rather turn to the FX market. Why not buy $1 million’s worth of Euros and hold on to it when we know there’s a possibility for a 1% increase next month. In essence, the bank makes profits in the smallest of opportunities. For large banks, a 0.0001% increase in exchange rates could mean hundreds of thousands or even millions of dollars as profits. For trades like us though, that kind of gain is easily ignored.
But what’s the difference between a bank and an actual forex company? Well, we will need to see how this usually works.markets
For example, according to those who trade on Forex.com markets and products the difference is quite significant when compared to banks. You see, a forex broker such as Forex.com is a service provider in this sense. They usually don’t trade themselves but allow people to trade through them. This naturally turns into a service for which they then charge for. The amount charged is usually the difference between the bid and ask prices of a currency pair.
So, considering this “service fee” it’s immediately clear that if you or I trade $1 million on the market, our profits will be much different from a bank’s profits. Why? Because the bank doesn’t need a service provider for this, it is a service provider itself.
For example, if the profit margin is 5%, that’s around $50,000 for the bank, but for retail traders, it would probably be between $45,000-$48,000.
What about central banks?
Central banks are a bit different in this regard. The main difference here is that these banks don’t trade for profit, they trade to uphold a fiscal or monetary policy. For example, let’s say that the USD is too strong for the economy and exports are becoming harder and harder. What the Central Bank would do in this situation is to sell a bunch of USD for other currencies. What this does is it messages the market that confidence in the USD is done because so much is being sold.
This would then depreciate the USD significantly, leaving the Central Bank in a loss, but that was exactly what they were trying to do.
Once again, the Central Bank’s job is to keep the currency in check and step in whenever the market is being too one-sided.
As mentioned at the beginning of the article, many companies trade forex. The funny part about this is that some of them don’t even realize they’re participating in the largest financial market in the world.
For example, imagine every single US company that operates internationally. They are forced to receive payments in the local currency right? Well, once they want to consolidate most of the company’s equity in USD, what do they do? They exchange their local currencies to USD, thus participating and sometimes losing quite a lot during the exchange.
Forex may not be widely spread as direct trading activity, but we all do it one way or another. This could be during a trip overseas or even when we buy stuff from offshore companies.