The development of trading software, availability of broad band internet connection at relatively low cost and finally the leverage facility offered by Forex brokers (http://www.earnforex.com/forex-brokers/) gave rise to retail Forex trading in the late 90’s. In the past two decades the industry had grown in leaps and bounds surpassing all expectations. All over the world, as per CitiFx’s global head of FX bank sales, the retail Forex industry now contributes between 5% and 8% of approximately $5.5 trillion spot Forex transactions executed on a daily basis. With such a volume being traded online by retail traders, it is but natural to question the benefits provided by the online Forex industry to the economy. Is it simply an activity which enables an individual to make a living or is it more than that? The following discussion provides an insight into the positive effects of the retail Forex industry on the economy.
An economy is considered to be strong only if its currency remains stable. Too much volatility will keep the investors at bay. In this regard, the central bank of any country keeps a vigil on the prevailing currency volatility. The central bank usually intervenes only when the currency becomes highly volatile. Globally, major financial institutions provide the bulk of the liquidity and keep the currency exchange rates in a stable manner. However, the liquidity conditions vary throughout each trading day as financial centers open and close across different parts of the world. For example, the Japanese economic data or unexpected comments from senior bureaucrats usually trigger sharp movements as there will be lesser number of institutions which will actively counteract the directional news. Similarly, the close of European trading session (New York afternoon market) usually impacts the liquidity. This adds to the risk level of the asset. Additionally, seasonal holidays (Christmas, Easter, and Ramadan) also impact the liquidity.
However, the online Forex industry rarely closes. As long as the market remains open, the online foreign exchange market keeps functioning. More than four million traders who operate through the online platforms continue to trade and provide liquidity, which is quite vital when the big institutions are not open. In this regard, indirectly, the retail Forex industry assists the economy. For example, let us consider that a commercial firm wants to hedge their cost of shipment urgently. The online FX market, through their retail traders, will be able to takes the other side of the trade. The commercial firm will also have a better price even though the major institutions are not open. The entire process saves valuable foreign currency which would have otherwise got evaporated due to lack of liquidity.
Brokerage fees bring billions to banks
The online Forex industry enables a trader to access the interbank liquidity pool. The price quoted by banks naturally includes their brokerage fee as well. With several trillion dollars’ worth of currency being traded in a year by retail traders through the online FX platforms, banks make several billions with fees. Every dollar earned as a brokerage fee is spent by the bank either directly or indirectly to support the smooth functioning of the economy. This includes funds for new ventures, revival of an ailing company with good prospects and even social causes. Without these billions from the retail Forex industry, the banks, which are currently facing tough time, would be hard pressed to delay or avoid several of the important tasks, which would speed up economic growth.
Additionally, the competition among banks to get a share of the brokerage fee pie from the retail currency trading industry has resulted in highly competitive exchange rates. This has a direct positive impact on the business and foreign travel expenses.
Last year, six of the top tier banks were fined by the FCA to the tune of $4.3 billion for manipulating the exchange rates in the spot Forex market. The traders representing the banks grouped together to alter the spot Forex rate in their favor. The incident happened even when there is a contribution of at least 5% of the daily volume by the retail traders through the online Forex platforms. Consider for a minute that the retail online trading facility does not exist. With little transparency in exchange rates, the banks would simply take their customers for a ride. A rise in manipulation will simply make businesses to re-think their investment plans. This would ultimately have a negative impact on the economy. The online FX industry is certainly doing their part in providing a transparent price mechanism, which is crucial for a healthy economy.
Assists price discovery
A vibrant price discovery mechanism assists an investor to mitigate risks in a free market economy. Thus, investors across the world look for opportunities to invest only in economy that supports transparent and efficient price discovery mechanism. Likewise, the central bank and government of developed and emerging economies take all the necessary steps to ensure an efficient price discovery system as it is directly linked with investments and future economic growth.
Now, the transparency in quotes in retail Forex trading platforms, as discussed in the previous paragraph, reasonably prevents informed participants from rigging the exchange rates. Additionally, those who trade through the online trading platforms also assist in an efficient price discovery process. An efficient price discovery process is characterized by quick change in the market price upon arrival of new data, from the old equilibrium to the new equilibrium. The change in the equilibrium actually takes places because of the interaction between the supply and demand forces. The efficiency increases with a rise in the number of informed market participants. The online Forex industry through the electronic trading platforms facilitates the creation of such a scenario and fuels economic growth indirectly.
There are millions of traders operating Forex platforms to make a living. At least, a portion of the money they earn is spent in and around their residing area. The process supports the local economies – a crucial point in equal distribution of wealth. By standing financially independent, a trader reduces (by avoiding state welfare) the burden on the government. There are also traders who employ locals to take care of their routine trading related tasks. Such a scenario exists only because of the availability of the online retail Forex trading industry.
The retail FX industry continues to register double-digit growth mainly because of its advantages over other forms of investing. Simultaneously, the industry also acts as a catalyst for economic growth. Thus, governments and regulatory bodies, understanding its contribution to the global economy, must remain committed to ensure that the industry continues to function in a fair manner through upholding a proper regulatory and mitigation environment.