The Inter-bank market has existed in Forex
for decades. Although it does not apply to retail clients, it is important to understand the history in order to get a well-rounded
view of how this market works. Here is a brief history of the brokers who have participated in that market and how it has evolved
since its early beginnings.
Foreign exchange brokers, unlike equity brokers, do not take positions for themselves; they only service institutional banks. The
role of the broker is to bring together the buyer and seller; to optimize the price - and quickly, accurately, and faithfully execute
the traders' orders.
Since the early 1970's, the majority of the foreign exchange brokers execute business via phone using an open box system - a
microphone in front of the broker that continuously transmits everything he or she says on the direct phone lines to the speaker boxes
in the banks. This way, all banks can hear all the deals being executed.
With the open box system, a trader is able to hear all quoted prices, whether the bid was hit, or the offer taken, and the following
What the trader is not able to hear is the amount of a particular bid or counter offer, or the name of the bank that is doing the
trading. Prices are anonymous. The anonymity of the banks that are trading in the market ensures the market's efficiency, ensuring
that all banks have a fair chance to trade.
Sometimes brokers charge a commission that is paid equally by the buyer and the seller. The fees are negotiated on an individual
basis by the bank and the brokerage firm.
Brokers show their customers the "bid" and "offer" prices made by other customers. There is either a two-way (bid and offer) or a
one-way (bid or offer).
Traders show different prices because they
"read" the market differently; they have different expectations and different interests. A broker who has more than one price on one
or both sides will automatically optimize the price. In other words, the broker will always show the highest bid and the lowest offer.
The FX market, through this process, has access to an optimal spread.
Fundamental and technical analyses are used for forecasting the future direction of the currency. A trader might test the market by
hitting a bid for a small amount to see if there is any reaction.
Another advantage of the brokers' market is that brokers might provide a broader selection of banks to their customers. Some
European and Asian banks have overnight desks so their orders are usually placed with brokers who can deal with the American banks,
adding to the liquidity of the market.
With the arrival of technology into the Inter-bank trading industry, electronic brokers have greatly reduced the need for telephone
brokering. In the last ten years, brokerage houses have closed or merged just to stay in business. Electronic systems provide a much
more fair and efficient way for banks to execute business. For the most part, banks can save substantially on commissions charged by
brokers who are less effective than the electronic systems.
The dealing systems' characteristics of speed, reliability, and safety are replicated in the matching systems.