What happens under the hood when I place an order in the forex market?

Question

I'm new to the field of forex trading and I'm trying to understand what actually happens under the hood when I place an order.

The point is that I've read everywhere that I don't own the underlying asset (what is the asset in a currency pair?) But only a contract with a counterpart where we agree to lose or win (possibly leveraged) the difference in price. I assume that what I lose my counterpart gains and vice-versa.

What's the role of interbank network then? Why do we need them? Why do we need liquidity providers? Are money (lots bought) really moved/exchanged by some actors?

Answer 1

If it's on a forex trading platform, then in many cases nothing actually happens except for recording the transaction on their computer. They don't actually need to buy the money that you've "bought" from anyone else. They know at some point that you're going to sell it again, and they can settle up, based on how much you have gained or lost. Since most customers lose money, they can carry on doing the trades that way indefinitely.

If you bought a large enough amount of a currency, then they might actually go to their brokers, buy the currency, and leave it sitting in their account. They are the counterparty. Again, they will assume that most customers will lose, once the trading fees have been applied.

Answer 2

I'll try to give an explanation on forex pairs. The asset being bought in a buy trade is the quote currency, USD in EURUSD pair. You buy this with the base currency, EUR in EURUSD pair. So if you "buy" 1 USD with 0.9 EUR, the price increases to 1.0 EUR and you sell it (close buy trade), you made 0.1 EUR. The opposite is true with sell trades, you "sell" 1 USD that you don't own so now you owe 1 USD but have 0.9 EUR on hand. The price moves down to 0.8 and now you buy 1 USD at that price to fulfill what you owe, you're left with 0.1 EUR profit.

You are correct in para 2. For all leveraged CFDs, not only forex but commodities, indexes, cryptos, etc., you're buying an agreement (basically a gambling ticket) for the price of the underlying asset to move in a direction.

Liquidity providers (market maker) broadly means anyone who offers to make a trade. For you to "buy" $1 mil USD with your EUR, someone needs to sell it. Your broker connects you to their whole network of liquidity providers; banks and other traders. In essence, everytime you make a trade, someone somewhere takes an opposite trade. This may not happen 1:1 as in if you make a 0.45 lot trade there's not another 0.45 lot out there. Your broker consolidates and fills existing offers (market taker) to fulfill your order. If there is not enough offers to fill your order, the next worse priced offer is taken and slippage occurs. Price moves up if more orders are buying up existing offers to sell and moves down if the reverse occurs.

I think that's generally what happens with all the relevant parties when you make a forex trade.

Answer 3

When you place a forex order, you're dealing with a contract for difference (CFD) on a currency pair, not owning the currencies directly. Your broker acts as the counterparty, potentially hedging their risk elsewhere.

The interbank network is where large banks trade currencies directly, forming the foundation for forex market prices. Liquidity providers, typically large financial institutions, offer buy and sell prices to ensure you can trade easily.

While your retail trades don't directly move currency, large institutional trades in the interbank market involve actual currency exchanges, influencing exchange rates.

Your broker may match orders internally or hedge in the wider market.

The interbank network and liquidity providers are crucial because they create the market your broker interacts with, ensuring fair pricing and trade execution. Though your individual trade might not involve actual currency movement, the overall market is based on real currency supply and demand.