There seems to be some confusion about the risks involved in trading currencies. There has been a lot of conversation about the interbank market being unregulated and therefore very risky because of the lack of oversight. This statement isn’t completely true.
A better approach to the discussion of risk would be to understand the differences between a decentralized market versus a centralized market and then determine where regulation would be appropriate.
The interbank market is made up of several banks trading with each other around the world. The banks themselves have to determine and accept sovereign risk and credit risk. This is why there are several internal auditing processes that keep them as safe as possible. The regulations are industry-imposed for the sake and protection of each participating bank.
Since the market is created by each of the participating banks which provide offers and bids for a particular currency, the pricing mechanism of the market is created by supply and demand. Due to the huge flows within the system it is almost impossible for a rogue trader to influence the price of a currency.
Because of the high volume of trading in the market today, with between two and three trillion dollars being traded every day, even the central banks can’t move the market for any length of time without the full coordination and cooperation of other central banks.
An ECN (Electronic Communication Network) is currently in the works which will bring buyers and sellers into a centralized exchange so that pricing can be more transparent. This will be a positive move for retail traders who will gain a benefit by seeing more competitive pricing and centralized liquidity.
This issue of course doesn’t apply to banks which is why they can remain decentralized without it creating any issues for them. Traders with direct access to the forex banks are also less exposed than those retail traders who deal with relatively small and unregulated forex brokers, who can and sometimes do re-quote prices and even trade against their own customers.
The discussion of regulation has come up because of the need to protect the unsophisticated retail trader who has been led to believe that trading forex is a surefire profit-making market.
For the serious and educated retail trader, there is now the opportunity to open accounts at many of the major banks or the larger more liquid brokers. As is the case with any financial investment, it pays to remember that nothing is guaranteed so that is why education, caution and common sense needs to be applied when trading in the forex market.
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