5. What causes the markets to move?
Market participants
Hedge Funds
Hedge funds have gained a reputation
for aggressive currency speculation
in recent years. There is no doubt
that with the increasing amount of
money some of these investment
vehicles have under management, the
size and liquidity of foreign
exchange markets is very appealing.
The leverage available in these
markets allow such funds to
speculate with tens of billions of
dollars at a time, and the herd
instinct typical in hedge fund
circles means that having Soros and
friends on your back is less than
pleasant for a weak currency and
economy. It is unlikely, however,
that such investments would be
successful if the underlying
investment strategy was not sound
and therefore it is argued that
hedge funds actually perform a
beneficial service by exploiting and
exposing unsustainable financial
weaknesses, forcing realignment to
more realistic levels.
The success of the Soros Quantum
fund in knocking sterling out of the
ERM in 1992, and the collapse of the
LTCM fund in 2000 has meant that
large funds have been offered less
liquidity from banks, and are thus
not the market force they once were.
A large order from a fund will still
move markets, especially where the
fund chooses to sell or buy to or
from several banks at once.
Commercial Companies
The international trade exposure of
commercial companies is the backbone
of foreign exchange markets.
Protection against unfavourable
moves is an important reason why
these markets are in existence,
although it sometimes appears to be
a chicken and egg situation?
Commercial companies often trade in
sizes that are insignificant to
short-term market moves, however, as
the main currency markets can quite
easily absorb hundreds of millions
of dollars without any big impact.
But it also clear that one of the
decisive factors determining the
long-term direction of a currency's
exchange rate is the overall trade
flow.
Some multinational companies can
have an unpredictable impact when
very large positions are covered
however due to exposures that are
not commonly known to the majority
of market participants.
Investors and Speculators
As in all other efficient markets,
the speculator performs an important
role taking over the risks that
commercial participants do not wish
to be exposed to. The boundaries of
speculation are unclear, however, as
many of the above-mentioned
participants also have speculative
interests, even some of the central
banks.
The foreign exchange markets are
popular with investors due to the
large amount of leverage that can be
obtained and the ease with which
positions can be entered and exited
24 hours a day. Trading in a
currency might be the "purest" way
of taking a view on an overall local
market expectation, much simpler
than investing in illiquid emerging
stock markets. Taking advantage of
interest rate differentials is
another popular strategy that can be
efficiently undertaken in a market
with high leverage.
ISO
codes