| At the very top of the forex market are transactions | | | | The forex market’s second tier essentially exists |
| which are collectively called Interbank transactions. | | | | within each individual bank. If you were to call your |
| The “Interbank” is not, as some people may | | | | local Citibank branch, they can arrange for you to |
| believe, an exchange. Rather, it is a collection or | | | | exchange your U.S. Dollar for the foreign currency of |
| compilation of agreements between and among the | | | | your choosing. In all probability, they will likely just |
| major money center banks in the world. | | | | move the desired currency from one bank branch to |
| An example may make it easier to understand this | | | | another one. This is known as a single party |
| thing we’re calling the “Interbank” market. In | | | | micro-exchange, so you are pretty much at their |
| most larger offices or business, perhaps even in your | | | | mercy as it applies to the foreign exchange rate |
| own home, there may be several computers which | | | | you’re quoted. You can either accept their |
| are inter-connected by means of a simple network | | | | “kind” offer or shop around for a better rate. |
| cable. Now, each computer operates independently | | | | Anyone who trades in the forex market should |
| until the moment it needs a resource, program or file | | | | consider paying their bank a visit, at least once, to have |
| from one of the other computers. When that | | | | an idea of their quotes. Certainly, it will be very |
| happens, computer A will contact computer B (or C or | | | | “enlightening,” if not downright shocking, to see |
| D, etc.) and request permission to access the needed | | | | just how profitable these transactions are… for your |
| resource. If the owner or operator of Computer B | | | | bank. |
| authorizes it, and if Computer B is functioning the way | | | | The third tier is the retail market. Established foreign |
| it should be, then the needed file or program can be | | | | exchange brokers such as Forex.com, Oanda and |
| accessed. Within minutes, Computer A’s request | | | | FXCM, etc. or any broker who wishes to set up a |
| is fulfilled. It works the same way in the forex | | | | retail operation, needs first to find a liquidity provider. |
| market; just substitute Computer A and Computer B | | | | The large majority of these forex brokers sign an |
| for Bank A and Bank B and let resources substitute | | | | agreement with a single bank. This bank agrees to |
| for currency. You now have the machinations for | | | | provide liquidity only under certain conditions: That is |
| the relationships that exist within the Interbank system. | | | | only if they can simultaneously hedge it on EBS, |
| By the same context, if you’ve ever tried to locate | | | | including their desired spread. |
| resources from a computer that isn’t united by a | | | | These spreads will be highly competitive, and that is |
| computer network, you probably know full well what a | | | | because that volume will be much greater than any |
| time consuming, inefficient, sometimes futile effort it | | | | single bank patron would ever transact. Bear in mind, |
| can be. You have to search each and every | | | | banks are in the business to make money, and third |
| independent computer until you’ve found your | | | | tier providers will almost never precisely match what |
| resource, copy it and then download it to your own | | | | actually exists on the Interbank system. Banks collect |
| computer. Regarding prices and forex currency | | | | the spreads and no agreement between them and a |
| inventory, the same issue exists within the Interbank | | | | forex retailer is going to alter their priority. |
| market system. If a bank in Taiwan occasionally | | | | Think of retail forex as a kind of casino. Most of the |
| transacts business with a firm in Sao Paula they need | | | | participants have little or no knowledge of forex trading |
| to exchange their currency. In this case, it can be | | | | effectively or successfully and, as expected, |
| quite difficult to determine what the proper exchange | | | | they’re consistent losers. The forex broker has |
| rate between the New Taiwan Dollar and the Brazilian | | | | the house advantage because of the inherent spread |
| Real should be. Because of situations such as this, | | | | system and the normal probability distribution of |
| the Electronic Broking Service (EBS) and Reuters | | | | returns. What results, is a system that plays one |
| established their services. For simplicity, we’ll refer | | | | loser against one winner and collects the spread. If |
| to this service as ESB. | | | | there is a dis-equilibrium within their internal order book, |
| In a way, the EBS service acts as a blanket over the | | | | a broker may hedge the exposure with their second |
| Interbank communication links. Through the EBS | | | | tier liquidity provider. |
| service, Interbank members are able to see how much | | | | Though it may not sound good, there are significant |
| currency is available, and the price(s) the other | | | | advantages to the speculators that work with them. |
| Interbank participants are willing to pay. It’s | | | | Since it is “internal,” many features, such as high |
| important to understand that the EBS is not in itself a | | | | leverage on an account with only a small balance, a |
| market nor is it a market maker. The EBS system is | | | | non-standard contract size, and commission-free |
| merely an application allowing bank members to see | | | | transactions can be provided which may not be |
| offers and bids from the other members. | | | | available through any other means. |