The significant amount of currency trading volume is due to institutional involvement. Institutions speculate and hedge through the currency market. Although impossible to gauge, there is a much greater percentage of institutional investments devoted to hedging.
Institutions will often hedge with their cash reserves in order to limit their exposure to fluctuating currencies. Take, for example, a U.S. company that imports over 80 percent of their materials used for production. For every separate supplier, there is a unique currency that has to be exchanged into dollars. When it's a multi-billion dollar company purchasing millions of dollars worth of materials, small fluctuations of currencies can cost millions of dollars per year.In order to protect its profits, a company will hedge against currency fluctuations. In the above example, a company importing most of its materials is inherently long on the dollar. In other words, if the dollar were to appreciate versus all other currencies, then it would be able to purchase more materials for the same costs. Consequently, a drastic decline in the dollar could literally bankrupt the company. If they were left without hedging, the only way to compensate for higher importing costs would be to pass on the price hike to consumers. Sometimes, consumers will switch products, thereby bankrupting a company. A company can combat exchange rate risk by shorting the dollar in the foreign exchange market.In sum, there are huge volumes of investments by multi-billion dollar companies entering in the Forex market every day. As a small investor, you can jump on the backs of major institutions for profits. Most multinational firms will be making similar bets, causing the development of strong trends.
