Not the interbank market

In the currency market you are trading the value of one currency relative to another. It varies from firm to firm, but most online forex dealers offer trading in the U.S. dollar vs. several major currencies: Japanese yen, the euro, British pound, Swiss franc, Canadian dollar and Australian dollar.

Most also offer trading in “cross rates,” or currency pairs not involving the U.S. dollar — the euro/yen(EUR/JPY), for instance. (For detailed information on currency quotations and trading conventions, see “A beginner’s guide to the forex market,” p. 52.)

It is important to keep in mind that when you trade with an online forex broker, you’re not really trading directly with the interbank market. The typical online currency brokerage essentially functions as a conduit or middleman.

True interbank participants operate as market makers, offering executable bids and offers (two-sided markets) in various currencies to other banks. In short, a bank belongs to the “interbank fraternity” if it has the appropriate credit lines and it provides a two-sided price quote.

Legitimate retail spot forex dealers have relationships with one or more interbank institutions with whom they can trade currencies. Typically, when you request a quote or place an order with a forex dealer, the broker contacts a bank. The currency desk at the bank gives your broker a quote, which will not be as good as the quote they’d provide to another interbank member. Your broker then gets back to you with a quote that is, in turn, inflated enough for the broker to make money off the spread. In other words, they have to sell to you high enough, and buy from you low enough, to make a profit on their offsetting transaction with the bank, which is profiting from the broker in a similar manner.

As a result, take a brokerage’s claim of “direct access” to the interbank market with a grain of salt. When you receive a quote from a firm, it’s difficult to know how accurate their market is, other than relying on the company’s reputation or contacting several firms to compare markets.

Another consideration with online forex dealers is whether the quotes they display on their systems are firm or “indicative.” If they’re firm, you can trade them immedi ately. If they’re indicative, you have to make a “request for quote” to find the actual tradable price — which means the dealer has to first get a price from the bank before he makes you a bid or offer.