Forex Unmasked – The Liquidity Pyramid and its Hidden Layers

If you are new to the forex market or an aspiring trader, then you may be oblivious to the core infrastructure that remains hidden behind trading platforms and individual technical indicators. The process of electronic trading is far removed from the fundamental structure of the market and the so-called liquidity pyramid, which provides an insight into forex capital and who it is controlled by. While it is a far from simple arrangement, it is one that has supported activity in the foreign exchange for generations.

forex market

Behind the Forex Market: Its Structure and Leading Players

To begin with, it is worth noting that the foreign exchange can be loosely categorized into two tiers; the wholesale tier and the retail tier. Different parties are involved with each, and play alternative roles in executing trades and generating profit. Consider the following: –

The Wholesale Tier: This refers to an informal and geographically diverse network of approximately central 1200 banks, selected currency brokerage firms and large financial corporations. These entities interact and deal on a regular basis, and this tier has formed the bedrock of the forex market for decades. When economists refer to the foreign exchange, they are largely discussing the wholesale tier.

The Retail Tier: The retail tier has enjoyed a huge surge in popularity during the last decade, as technological advances and the development of online trading has opened the market to independent investors. This tier is populated by independent agents and online brokerage firms, who work together to buy and sell foreign currency. This tier also accounts for the vast majority of liquidity within the market, so it has also gained significant influence in a short space of time.

The Pyramid of Liquidity: How this Relates to the Forex Market

Beyond these tiers exists the pyramid of liquidity, which provides further insight into the structure of the foreign exchange and the share of global liquidity. There are four sections of the pyramid, relating to power money, bank loans, the securitization of debt and derivative products respectively. Interestingly, there is a significant discrepancy in terms of the share of global liquidity and which parties are involved in alternative segments of the pyramid.

Power money and bank loans account for just 7% of the total global liquidity within the market, for example, despite controlling the vast majority of physical capital and wealth. Power money is the total federal reserve capital that sits on the balance sheets of central banks, who operate primarily as speculators and enter into the market without covering their positions. In contrast, financial corporations tend to serve as hedgers, which means that they purchase investments to hedge against one another to achieve security against price movements.

Working alongside commercial banks are regulated currency brokers (Alpari being a prime example due to their monthly trading volumes), who predominantly act as intermediaries, they account for the bank loan segment of the pyramid. It is these two segments that economists are referring to when they discuss the economy or cite the wholesale portion of the foreign exchange, which can cause
issues when trying to achieve a wider financial overview. Much more than this, however, they support the notion that genuine capital is no more tangible than derivative products or security wealth in the forex market. 

The Retail Tier,  Market Liquidity and the Bottom Line for Traders

Both the securitization of debt and derivative products relate to the retail tier of the forex market, and between them account for 93% of the exchanges liquidity. Again commercial banks and brokerage firms are active in these sectors, largely interacting with independent traders to execute transactions in search of profit. The difference with the retail tier is that it deals in derivative products and liquid assets, which free traders from the burden of ownership and allows them to profit regardless of the performance of a specific financial instrument.

The forex market is renowned for the level of liquidity that it offers to traders, and the ability to trade derivative products and liquid assets in high volume is largely responsible for this. This also explains why the there is such  a discrepancy in terms of the share of global liquidity, as trading on margins rather than an individuals assets price allows for a greater degree of flexibility when it comes to operating profitably on the foreign exchange. More than this, it proves that real money is merely a claim on various types of asset and financial products, and hold no additional value within the market.


This post was written by a human editor of , a niche human edited directory providing quality listings, user-ratings and endorsements to assist users to find the best resource webpages (not just websites) within the Foreign exchange markets amongst clear, dynamic and intuitive categories.

Image Credit:
Danilo Rizzuti – Free Digital Photos.Net

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