Many traders want to know how to trade in position with the banks. Why is it so important? We're going to learn all about it in this bank trading strategy.

Forex is by far the largest financial market in the world with a daily volume of $6.6 trillion. Every party, from big banks to individual investors, takes part in the forex market in the hope of making profits from currency fluctuations. A large portion of forex daily volume is controlled by the big banks. They have the power to dictate which direction the market moves, and when they want it to happen. Thus, it is in your best interest to not trade against the banks. After all, they are profitable in 9 out of 10 trades, while retail trader loses 9 out of 10 trades.

Bank Trading Strategy

To get the point across, let's break down the players in the forex market before we get into the bank strategy:

 

Who Trades Forex?

If you are reading this article, chance is you are a forex trader, or at least you plan to be on in the future. As a player in the forex market, it is very advisable that you know who partake in forex trading and what reasons they have to trade forex.

 

Commercial and Investment Banks

Commercial and investment banks are the biggest participants in terms of total currency volume traded. However, it is the big banks (such as JP Morgan, Deutsche Bank, HSBC, etc.) that control the interbank market thanks to their financial power. For the record, the interbank market is not exclusive to banks. Other participants like investment managers and hedge funds also make this category. Apart from conducting their own trades, the banks also offer forex trading services to their clients by acting as dealers. They make money from this through the bid-ask spread.

 

Central Banks

Representing their respective nations, the central banks play a vital role in the forex market. They can significantly influence currency rates through open market operations and interest rate policies. Also, some of them are tasked to fix the price of their currencies in the market, so they may deliberately strengthen or weaken their currencies if necessary. All the actions that the central banks take are aimed to stabilize or improve their nations' economies.

 

Investment Managers and Hedge Funds

Investment Managers and Hedge Funds are the second biggest players in the forex market after the banks and central banks. Investment managers engage in forex trading for services such as pension funds, foundations, and endowments. If they have international portfolios, they will have to buy and sell currencies. They may also make speculative forex trades. On the other hand, speculation is part of hedge funds' investment strategies in the forex market.

 

Multinational Corporations

Multinational corporations whose business activities involve importing and exporting goods and services certainly contribute to forex transactions. Consider this case: an Italian tire company imports components from the US and sell their product in Japan. The profit this company earns in Yen must be converted to EUR, which is subsequently converted to USD to buy more components.

In order to minimize the risk of volatility in foreign currencies, that Italian company might buy USD in the spot market, or make a currency swap agreement to acquire USD in advance before buying the American components. This way, the Italian company reduces the exposure from foreign currency risk.

 

Retail Traders

A trader like you is called an individual trader, or retail trader, as you trade with your own money through a broker or other trading agents. The number of retail traders is growing exponentially in recent years. Around 90% of all traders are retail traders. However, retail traders' contribution to the forex market is still tiny compared to the other market participants in terms of the trading volume. Retail traders may use the combination of fundamentals and technical indicators to approach the market.

 

Who is Smart Money?

Now that we understood each market participant in the forex market, there is another term that we need to learn: smart money. Generally, smart money traders can be defined as the largest market participants whose capital can change the market patterns. Their trading volume is so large that their positions cannot be opened or closed in a single order without apparent price spikes. Smart money includes major investment banks, hedge funds, massive global companies, insurance companies, prop firms, etc.

Based on a survey in 2019, banks dominate the market share of daily forex volumes worldwide. Out of the top 10 institutions on the list, eight of them are banks. US-based JP Morgan leads the market, followed by Swiss' UBS and XTX Markets to make up the top 3.

Name Market Share (%)
US - JP Morgan 10.78
Swiss - UBS 8.13
UK - XTX Markets 7.58
Germany - Deutsche Bank 7.38
US - Citi 5.53
UK - HSBC 5.33
US - Jump Trading 5.23
US - Goldman Sachs 4.62
US - State Street 4.61
US - Bank of America Merrill Lynch 4.5

 

XTX markets and Jump Trading are the only non-bank entities from the list above. But like the banks, these two entities are also smart money that acts as a market maker. Since smart money involves in market-making activity, they will drive the market based on supply and demand.

 

What is Bank Trading Strategy?

The forex bank trading strategy is a method to identify the likeliest price levels for the banks to open and close their positions based on supply and demand areas. The banks control the majority shares of forex daily volumes, so when they move, the market moves. With this piece of information in mind, we can track their trading activity as the basis of bank trading strategy.

 

The 3 Key Steps

When it comes to forex trading, the banks conduct their activity in three steps i.e. accumulation, manipulation, and distribution/market trend. Accumulation is the step where banks enter their positions, manipulation is the phase where a false push appears, distribution is the stage where a trend begins.

Before we discuss these three steps in detail, we should keep in mind that the law of supply and demand applies to forex trading. If you want to buy a currency in the market, there must be someone else who is willing to sell. Likewise, if you want to sell a currency, another trader must be willing to buy. The buying and selling counterpart always happens in every transaction.

So based on the law above, if the bank plans to buy a large position, they must find an equal amount of selling pressure. It would be easier for us to spot their trade if they enter the market in one large order. But obviously, this is not the case. What they do instead is to place their order over time, which is also known as the accumulation step.

 

1. Accumulation

Accumulation is the first step that you must identify in the bank trading strategy. The banks enter the market by accumulating either a long position that they will later sell at a higher price or a short position that they will later buy back at a lower price. If we can identify the accurate price levels where the banks are accumulating, we will also be able to identify the direction of upcoming price movements. That's why accumulation is a very essential step in bank trading strategy.

Unlike retail traders, banks must enter positions over time due to their massive trading volumes. They do this to conceal their activity as a single large order would spike the market.

To understand what the accumulation step looks like, let's see the USD/CHF chart below. Accumulation is characterized by a ranging market where the price moves sideways. This is the area where the banks regularly entered the market to accumulate their desired position at intervals of hours or days.

Accumulation

 

2. Manipulation

Manipulation is the next step after accumulation. This step is characterized by a false push that starts a short-term market trend. Retail traders often fall victim to market manipulation. They would enter positions when they see there is a potential breakout. But it turns out it is just a false push and the price later moves in the opposite direction.

If you're ever in this situation, it's not bad luck. It does not mean the forex market is being unfair to you. Most likely, though, you're being used by the banks. How so?

Let's say the banks are trying to enter or accumulate a long position. At the same time, they will also create selling pressures. They will try to 'manipulate' retail traders to enter short positions.

To track the banks, we need to identify the false push that marks the end of an accumulation phase How can we identify this false push or manipulation? Let's take a look at the chart below.

Manipulation

For bearish market, a false push can be identified when the price moves beyond the high of an accumulation period which indicates that the banks have been selling into the market. After the false push, we will most likely see a short-term downtrend.

For bullish market, a false push can be identified when the price moves beyond the low of an accumulation period which indicates that the banks have been buying into the market. After the false push, we will most likely see a short-term uptrend.

 

3. Distribution or Market Trend

Distribution is the step where we can make profits from the market. At this point, the banks have accumulated their position and created market manipulation. They are not trying to conceal their presence anymore. Now, banks will try to push the price toward a particular direction, meaning that this is the phase where a market trend begins.

Distribution

Figuring out the market distribution can be considered to be the easiest of the three steps, but this task is highly dependent on the previous two steps. It is very imperative that we avoid the manipulation trap. If we understand how the banks manipulated the market, we will be able to identify the direction of the market trend that banks attempt to push. Our next task then is to simply ride the trend.

 


This is the first part of a bank strategy for retail traders. In the next part, we're going to reveal the implementation of the strategy in trading and several key tips on how to trade like a bank.