Trade Systems On Forex

Trading with brokers. Foreign exchange brokers, unlike equity brokers, do not take positions for
themselves; they only service banks. Their roles are to bring together buyers and sellers in the
market, to optimize the price they show to their customers and quickly, accurately, and faithfully
executing the traders' orders. 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. Because of the open box system used
by brokers, a trader is able to hear all prices quoted; whether the bid was hit or the offer taken;
and the following price. What the trader will not be able to hear is the amounts of particular bids
and offers and the names of the banks showing the prices. Prices are anonymous. The anonymity
of the banks that are trading in the market ensures the market's efficiency, as 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 prices made by other customers, either two-way (bid and offer) prices or one way
(bid or offer) prices from his or her customers. 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. Therefore, the market has access
to an optimal spread possible. 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.
Direct dealing. Direct dealing is based on trading reciprocity. A market maker—the bank making
or quoting a price — expects the bank that is calling to reciprocate with respect to making a price
when called upon. Direct dealing provides more trading discretion, as compared to dealing in the
brokers' market. Sometimes traders take advantage of this characteristic. Direct dealing used to be
conducted mostly on the phone. Phone dealing was error-prone and slow. Dealing errors were
difficult to prove and even more difficult to settle. Direct dealing was forever changed in the mid-
1980s, by the introduction of dealing systems. Dealing systems are on-line computers that link the
contributing banks around the world on a one-on-one basis. The performance of dealing systems
is characterized by speed, reliability, and safety. Dealing systems are continuously being
improved in order to offer maximum support to the dealer's main function: trading.
The software is rather reliable in picking up the big figure of the exchange rates and the standard
value dates. In addition, it is extremely precise and fast in contacting other parties, switching
among conversations, and accessing the database. The trader is in continuous visual contact with
the information exchanged on the monitor. It is easier to see than hear this information, especially
when switching among conversations. Most banks use a combination of brokers and direct
dealing systems. Both approaches reach the same banks, but not the same parties, because
corporations, for instance, cannot deal in the brokers' market. Traders develop personal
relationships with both brokers and traders in the markets, but select their trading medium based
on price quality, not on personal feelings. The market share between dealing systems and brokers
fluctuates based on market conditions. Fast market conditions are beneficial to dealing systems,
whereas regular market conditions are more beneficial to brokers.
Matching systems. Unlike dealing systems, on which trading is not anonymous and is conducted
on a one-on-one basis, matching systems are anonymous and individual traders deal against the
rest of the market, similar to dealing in the brokers' market. However, unlike the brokers' market,
there are no individuals to bring the prices to the market, and liquidity may be limited at times.
Matching systems are well-suited for trading smaller amounts as well. The dealing systems'
characteristics of speed, reliability, and safety are replicated in the matching systems. In addition,
credit lines are automatically managed by the systems. Traders input the total credit line for each
counterparty. When the credit line has been reached, the system automatically disallows dealing
with the particular party by displaying credit restrictions, or shows the trader only the price made
by banks that have open lines of credit. As soon as the credit line is restored, the system allows
the bank to deal again. In the inter-bank market, traders deal directly with dealing systems,
matching systems, and brokers in a complementary fashion.
 

Continu: Exchange Rate Determination