A few basic questions about FOREX

Beginner Questions
1

Hi,
I have a couple of simple questions that have been nagging me:

  1. How are the prices of currency pairs determined? Is it by the amount of people trying to buy versus the amount trying to sell?

  2. Is FOREX the only international currency market? Are all currency trades required to go through FOREX?

  3. When a large bank in Spain (for example) trades millions of EUR for USD are they required to do it through FOREX? If not, how does FOREX find out about the trade?

  4. Imagine this scenario: Everyone in the world (literally) uses the same automated trading robot. The robot tells everyone to sell USD and buy EUR. From what I understand this would mean that the price of USD would fall to $0 and the price of EUR (as compared to USD) would rise to infinity. Then, when the robot tells everyone to sell EUR, everyone would profit. Obviously this cannot be so. If someone profits it is at someone else’s expense; is it not? If this question is unanswerable with the pretense of every single person making these transactions simultaneously, then pretend it is 90% of the world instead of 100%.

I await your input :slight_smile: Thanks a lot!

2

Good Questions. I’ll try to answer and if I’m wrong I hope someonw will correct me.

  1. The number of contracts (or lots) bought is always exactaly equal to the number sold. Price is the consensus opinion of the market of value at that point in time. When those wanting to buy are willing to pay a higher price, and those willing to sell want a higher price, the price goes up. When those wanting to sell are willing to accept a lower price, and those willing to buy want to buy at a lower price, price goes down.

  2. Forex isn’t the only market. It is the retail spot market. Currencies are also traded through the interbank markets, like Citi calls Chase and gets a quote on selling 10 billion yen for dollars. Or Catapiller calls Citi and asks for a quote to repatriate 10 billion yen for dollars. They have to do that if they sell their tractors to Japan and want to bring the money home. Currencies are also traded as forwards, futures and options, just like futures and options on oil or gold.

  3. See above. Forex may not know of large bank transactions until much later, if ever.

  4. Generally, yes, it’s close to a zero sum game. The spread means the brokers always win, unless they do something stupid like losing it all with discretionary trading. If some win, others must lose. Review answer to #1. If everyone wanted to buy, there would be no sellers, thus no trades, and price wouldn’t move at all. What keeps this from happening is brokers would sell, at a very high price, and buy back later at a much lower price, making a bundle off everyone silly enough to trust their hard earned money to a stupid robot. This happens every day. Remember, the number bought and sold MUST always be exactly equal.

Hope this helps,

Happy trading

3

Great response, thanks a lot. I have a couple of follow-up questions:

  1. When you buy USD/EUR is there someone selling USD/EUR at that same instant? I understand that 1 buyer means 1 seller, but what if no one is looking to buy at that moment?

1a. If pending orders queued up until the next tick, what happens if there is a discrepancy in the #buyers versus #sellers?

Price is the consensus opinion of the market of value at that point in time. When those wanting to buy are willing to pay a higher price, and those willing to sell want a higher price, the price goes up.

How does Forex determine the price buyers are “willing to pay?”

Forex may not know of large bank transactions until much later, if ever.
Don’t these large transactions cause substantial changes in the price of currency? If Forex NEVER finds out about the transaction then does the value of the respective currencies even change? If so, how is that information conveyed to the market?

Thanks a lot :slight_smile:
-Mike Furlender

4

  1. There is always someone willing to buy, at a low enough price, in a very liquid market. Brokers and market makers make a fortune buying very cheap when no one else wants to, and selling very dear when no one else wants to sell. They are very good at it and compete against each other, keeping spreads low.

  2. It happens fast. Stop and limit orders are placed in the market above and below price at all times. When the price touches those orders, the transaction is made.

  3. Eventually the money makes it’s way back into the market, affecting the value of that currency. Also, even if it’s just a paper transaction, like an option, eventually it must be offset by an opposing option, or the cash must come from somewhere. Forex is the largest cash market in the world, so most times, most of the cash will come out of or go into it. More supply will drive down prices and buyers will scoop it up at what they think are cheap prices.

5

So are you saying that stop loss/limits are used to determine the price change at the next tick?

6

Only if there is someone on the other side to complete the transaction. Brokers can see where the stops are. Others can guess they are just above or below round numbers and S/R points. They will buy on good momentum just below say a 1 Hr 100 SMA line, betting if it goes through it will hit stops and drive higher. There are always lots of people on both sides of the price plotting and scheeming. When they come together, either at the current price or a little above or below, a transaction is made and another tick apears on the chart. Well capitalized brokers and market makers with the very best of technology are often on the other side of any trade. If you win a pip, you may just have taken it from your own broker, or a trader at the desk of Goldman Saches. What are the odds of that? Not as good as some would like to pretend, that’s for sure.