Who are the financial markets participants?

Who are the financial markets participants?

Canary Wharf
Photo by @i.m20

Let’s start by listing just some of them – traders, hedge funds, proprietary trading firms, brokers, liquidity providers, banks, venues, and exchanges.On top of this, Central banks sometimes intervene and in some cases Regulators oversee. 

Market Participant Definition

At its most basic, a participant in the market is a person or business or institution that buys or sells (trades) a financial instrument. Some take part on the demand (buy) side and some on the supply (sell) side. Some are investors, others speculators. Some (most) are institutional and others (you and me) are retail.

Supply vs demand participants

Let’s take a look at Forex as an example. A forex trader will place their FX order through a broker like CALUSO who accesses liquidity, provided by interbank institutions. The orders are then routed through the requisite exchanges. Participants can be on the demand side. Retail participants may borrow money or use savings to invest or trade. Or, they may be on the supply side. This means participants are actually providing the capital that people/firms want to purchase as (usually) investments. 

Investor vs speculator participants

The distinction between these two is part time-scale and part the level of risk they are prepared to take on. An investor can be an individual or company that regularly buys equity or debt securities for financial gain over the medium to long term. A speculator will take on more risk as they trade forex, shares, commodities, bonds, for, usually, short-term profit. Retail participants are classed as speculators. 

Institutional vs retail participants

As we’ve discussed before, institutional investors are banks, financial services firms and pension funds who tend to make large longer-term investments. Retail investors tend to be individuals or small groups who invest in markets such as stock markets, or who trade forex markets through brokers.

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The process of Trading

Sticking with the Forex example, when a simple trade takes place on your trading platform, the following are involved in a series of events that leads to the transaction being executed: retail traders, brokers, central banks, banks/liquidity providers and other financial traders and entities.

Retail traders

Retail traders will place their FX currency pair order on their platform (such as the MetaTrader MT4 platform) and their broker will then attempt to fulfil that order at a price that should be the best price/quote they can achieve for their client.

The Broker

The broker provides the retail trader with access to the market and usually gets a commission on every order it fulfils. A broker might get a proportion of the spread or get both a commission and share of the quoted-spread.

Brokers come in two main variations:

  •     Dealing desk or market makers who will act as the counterparty of the trades you place. You should know that the market maker profits from losing trades!
  •     No dealing desk/ECN and STP brokers who route trades directly and transparently into the market for execution with no interference.

Banks and liquidity providers

Banks handle billions of individual FX transactions in high volumes every day. Such are the volumes they trade that they can often influence future movements of financial markets in favour of one currency or another. 

Banks provide the most liquidity and financial lubrication to the trading system and it is estimated that the five largest banks conduct over 55% of the FX volumes in financial markets. We’re not talking high street banks here. EBS and Reuters are two of the most highly-rated interbank platforms and others include AutoBahn, Currenex, Hotspot, Liquid-X, 360-T.

Banks in the FX market make most of their profit from the execution of transactions for their worldwide corporate customers. These are businesses which operate across international borders and need to set prices for their currency transactions.

Other financial institutions such as investment funds and insurance companies tend to execute orders through a broker with institutional solutions or banks. They often enter the markets for the purpose of risk management or speculation.

Central banks

The Central bank of a country has a very specific set of functions. In the UK these include inflation control and the determination of monetary policy (the amount of money is in circulation). They may pursue policies such as ‘quantitative easing’ which adds liquidity and confidence to the markets.  But the main function of all Central Banks is the setting of their countries’ interest rates from which commercial banks take their lead in setting their own rates.


Trading exchange
Photo by @JJFarquitectos


Trading Mechanism Participants

So, when you place your Forex order, you involve yourself, the trader, a broker and a liquidity provider such as a bank. These make up what we call the ECN (Electronic Communication Network) which is a decentralised exchange, usually virtual, where your order would be executed.

Central Exchanges 

In a central exchange or market all orders are routed to one single central-exchange and there are no competitors. The prices of securities that are quoted on this exchange are the only prices available to investors and traders who wish to buy or sell.

The NYSE (New York Stock Exchange) is a centralised market. Orders are routed to the exchange and matched with a counter order. That means that the price at which one party wants to sell and another to buy are the same. In this type of centralised market pricing is fully transparent for all participants to see. 

A clearinghouse sits between buyers and sellers to ensure the integrity of all transactions as they are routed through the exchange. This protects the interests of both parties and reduces risk which in turn helps ensure the safe functioning of the centralised market.

By contrast the forex market is not and cannot be centralised due to the differing sovereignty of all currencies. This means that pricing is not transparent and market participants must search for the best prices from competing broker-dealers around the world.

Institutional brokers

The client list for an Institutional broker will include hedge funds, pension funds and banks. They are unlikely to take on retail clients unless these dealt in very large volumes/values generating significant numbers of orders.

Normally institutional brokers will charge their clients a lower percentage of commission and apply tighter spreads. They may also have access to the interbank trading systems which retail clients can’t access.

Individual brokers will cater to clients of all sizes and types from professional traders and high net worth individuals to institutional clients.

Institutional Traders and Banks

We’ve already divided traders into two types, retail and institutional. Institutional traders buy and sell securities for corporate groups and institutions and they may oversee the management of pension funds and mutual funds. Sometimes they trade on behalf of the banks themselves to generate income and profits.

Recent years have seen a narrowing of the gap between retail and institutional trading. Now, the speed of access to markets, the proliferation of market analysis and data and the spreads and commissions retail traders pay have together helped to reduce the competitive advantage enjoyed by institutional traders.

Nevertheless, those institutional traders working at tier 1 banks, still have advantages. They can access more securities for trading purposes like swaps and options. They can get early access to and help to price IPOs (Initial Public Offering) and they have the clout to negotiate cheaper trading fees. They tend to be guaranteed the best price and execution due to their restricted interbank access.

Proprietary Trading Houses

Proprietary trading firms are often divisions of commercial banks investing and trading for their own profit rather than on behalf of their clients. This is sometimes called ‘Prop’ trading. These traders deal in stocks, currencies, bonds, commodities, derivatives and other financial securities with the firm’s money rather than using their clients’ funds.

For prop trading to be practical and ethical, the proprietary trading desk is usually separated from other trading desks at its mother bank or institution. It is required to work autonomously. Like other large trading entities, many prop trading firms have access to the interbank ecosystem and enjoy the advantage of lower trading costs.

Commodities Brokers

Our earlier lesson explained how commodities brokers specialise in trading commodities that are soft (e.g. sugar, wheat, livestock) or hard (e.g. precious metals, oil and gas). These are tangible goods that are traded globally and which underpin much of the global economy. Typically they are traded in the form of options, futures and other financial derivatives.

Market Participants Summary

We’ve seen that there are many participants in the business of trading. Some are specialists in a type of financial instrument. Others are characterised by the size and scope of their clients and their access to funds. It’s good to know how these different participants operate and how they make their money. By developing your own understanding you will be better able to improve your own trading outcomes.  

We now move on to look at trading exchanges in more detail and start getting into the detail of how you implement trades for yourself.

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