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Where do Forex prices come from?

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Where do Forex prices come from

Stocks are traded on central exchanges, providing a transparent price discovery mechanism. Stock traders from all over the world inflate purchase and sell prices, and then bid prices are placed in a descending order as the order prices are listed in ascending order in the order history. The transaction is executed when the bid price matches the asking price, leading eventually to a fair price per share. However, the novice forex trader may wonder about the source of currency exchange rates, especially since the Forex market is a decentralized exchange operating outside the official cabin. In this guide we will try to explain the source of price flow offered by forex brokers.

Where do Forex prices come from
Where do Forex prices come from


Participants in the Interbank market
Spot markets, futures markets and the SWIFT (Interbank Global Banking Association) constitute the so-called interbank market. Investors in the market include investment banks, commercial banks, hedge funds, major trading companies and central banks. There are different purposes for each of these institutions to participate in the market by buying, selling or exchanging currencies. For example, commercial banks may want to buy, sell or convert billions of dollars a day. These institutions can trade with each other directly. However, transparency and best price considerations drive these parties to trade through the interbank forex platforms such as Electronic Broking Services (EBS), Bloomberg Platform and Eikon (Thomson Reuters). These three platforms create channels of communication between thousands of banks. Of course, traders in the interbank market do not disclose whether they are interested in buying or selling a currency. These platforms at any time offer two different prices, one for purchase and the other for sale, which is presented to participants in the trading platform.

Example of major currency pairs
If we assume that a major bank wants to buy the euro currency worth up to $ 3 billion. The Bank offers the purchase and sale prices that it is prepared to deal with. There is usually a spread to cover the expenses incurred by the bank (orders costs, volume, inventory costs, competition and currency risk). Let's now assume that the bank's agent will show selling and buying prices at 1.14203 and 1.14208, respectively. Similarly, let's assume that there are other dealers representing other banks who will offer selling and buying prices to the same pair as follows.

Sell ​​Buy Volume (USD)
3 billion
1 billion
4 billion
Banks 1, 2 and 3 are referred to as liquidity providers in the market. Forex brokers open clearing accounts with liquidity providers, and these accounts are linked to Aggregator. This program collects data from different sources of liquidity and displays them in a single window. In addition, the orders sent by the brokerage client are compared with the different offers of the liquidity providers in order to reach the best possible spread. The aggregation program ensures that the customer will get the best buy or sell price available right now.

Based on the data mentioned in the table above, the aggregation program will choose 1.14207 and 1.14208 as selling and buying prices, respectively. The program then adds a margin to the selected prices as compensation for the risk to the broker. The Broker can at any time adjust the value of the added Spread as he deems necessary. If we assume that the broker adds one point as a spread premium, the final selling and buying prices that will appear to the customer will be 1.14202 and 1.14213, respectively. The table above shows that $ 4 billion deals can be executed at the selling price and $ 3 billion deals at the purchase price. However, the forex broker may get a better price by splitting volumes by the bundling program and sending it to more than one liquidity provider.

Example of secondary currency pairs
When dealing with currency pairs with limited volumes, compared to major pairs, the aggregate program splits volumes on a number of liquidity providers. In addition, the average implementation price rises. For example, let's assume that a single trader wants to open a $ 3 million deal on the AUD / CAD pair. As mentioned above, bids from the three banks can be arranged as follows:

Sell ​​Buy Volume (USD)
Bank 1 0.9890 0.9895 1 million
Bank 2 0.9892 0.9894 2 million
Bank 3 0.9894 0.9896 1 million
If the broker adds a 3-pip spread over the AUD / CAD pair, and since the highest selling price is 0.9894 and the lowest bid price is 0.9894, the liquidity consolidation program will display bids on the trader's screen at 0.98925 and 0.98955. Once the trader has placed the purchase order, the volume is split into two parts, then a $ 1 million order is directed to Bank 1 and a $ 2 million order is sent to the Bank2.

The Smart Commands command in the aggregate program calls quotes from different liquidity providers if the size of the order is too large. For example, the program can divide a $ 10 million order into five orders worth $ 2 million and then ask bids on that basis from several banks. Once the quotes arrive, the program selects the best price for the trader while at the same time protecting the broker against any potential risks. However, it should be noted that the liquidity provider may reject the order when it is sent due to the recent look feature. If the liquidity provider believes (especially as he has a general view of the flow of orders in the market through his highly developed platforms) that

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