Have you ever thought about the market participants? If the answer is no, you should certainly change that. Markets are driven by the activity of market participants and in order to try to reconstruct what other traders might do, you first need to have a basic knowledge of why they trade, how they trade, and other known characteristics that influence their decision making. Only then will you be able to anticipate where the market is going next.
· Real Money
· ACBs (Asian Central Banks)
· BIS (Bank of International Settlements)
· Hedge Funds
· System Traders
· Hot Money
· Option Players
· Commercial ParticipantsAnd finally...
· Retail Traders
Dealers – a dealer makes a market by quoting his clients a bid price (the price where the customer can sell) and an offer price (the price where the customer can buy). The difference between those two prices – the spread – is the dealer’s profit. Dealers at large banks build the interbank market in the FX markets. A dealer has the task to handle the clients‘ orders and manage his market exposure. As he takes the opposite side of the client’s trade, he can either look to quickly get rid of the exposure in the interbank market or, he can hold on if he thinks he might profit by sticking to this position. Dealers can hold short-term speculative positions, but almost all of them finish the trading day flat (no open positions at the end of the day). Dealers participate quite often in stop hunting, but they are vulnerable too. If orders ahead of the stop loss level prove to be too large, they will have to cover quickly.
Real Money – investment funds – pension funds, mutual funds. They are not interested in short-term speculation, but mostly look to manage their currency exposure. They hold positions for a longer time period and usually stabilize the markets as they tend to buy the dips and sell the rallies rather than focus on momentum.
Sovereign Players – sovereign wealth funds and central banks. They are powerful market participants and information that a sovereign player has been buying/selling is something professional traders pay much attention to.
ACBs – they are also sovereign players, but they have some special characteristics: They engage mostly in short-term trading and their goal is to recycle their FX reserves. ACB tend to have their orders for the London session clustered at the Asian high and low.
BIS – a powerful institution based in Basel, Switzerland that handles trading for central banks. Their orders can have a large impact on market, especially when things are rather quiet, so pay attention when you hear anything about some buying or selling coming from Basel.
Hedge Funds – they trade both for the short- and long-term. HFs trade aggressively and unload their positions quickly if they got on the wrong side, which can lead to some large squeezes. Their goal is to ride currency trends as long as possible, but there are also some funds focusing on short-term predatory trading, such as i.e. stop hunting. HFs tend to be well-informed players, so if flow info about multiple HFs buying/selling is streaming, you want to keep that in mind.
System Traders – algos mainly looking for momentum. They buy/sell on breakouts and help to accelerate stop hunting. Things can get quite volatile if there is not enough liquidity on the other side to stabilize the market.
Hot Money – Some HFs and Systems are part of this group, but hot money can also be prop trading firms and high net worth individuals. They are looking for short-term momentum trades, mostly taking advantage of the weaker side of the markets. They add noise and volatility to the market and do not care much about long-term fundamentals or similar.
Option Players – they sometimes have to manage their exposure in the FX option market through the spot market. Most of this activity is bound to option expiries (NY cut 10:00 EST/15:00 GMT) and price tends to be attracted to expiry levels. The market won’t care much about the expiry levels if there is a lot going on, but if we have thin markets with little action, it certainly can.
Commercial Participants – corporations and firms handling their exposure to fluctuations in exchange rates. They are not speculating, but solely focusing on hedging, so their behavior is not predictable. However, their orders can be quite large sometimes, so their buying/selling can have an impact.
Retail Traders – most of them are losing money, so it pays off to think about what the common retail trader might do and exploit his weaknesses. Frequent mistakes they make is trying to pick a top or bottom and putting their stops at obvious levels while going against sentiment or trend.
Now that you have some basic knowledge about who is participating in the market and are aware of some of their characteristics, you can start to incorporate this knowledge into your trading.
The practical application of all this is a method that incorporates market rules (market microstructure), external factors that affect the market environment, and our knowledge about other participants within the market.
The goal is to take advantage of the predictable behavior of other market participants and exploit their weaknesses. This might sound like a complicated process, but it becomes easier with a proper bit of training and experience.