Forex trading is the name of the game in the foreign exchange market where people trade currencies.
A lot of things require such exchanges. For example, if you live in the United States, and you want to purchase cheese imported from France, either the company or the buyer must pay in euros (EUR). Therefore, the U.S importer would be responsible for exchanging the correct equivalent of U.S dollars (USD) into euros.
In addition to purchases, this also goes for traveling in foreign countries. If a French tourist wanted to see the pyramids in Egypt, they would have to convert their money into local currency.
The primary reason that the forex market has become the biggest financial market worldwide is due to the requirements for exchanging currencies. With the average daily trade value nearly $2,000 billion USD, it overshadows other markets in size. Of course, the total volume is always changing, but the Bank for International Settlements (BIS) had reports in August 2012 that the Forex Market had traded over $4.9 trillion USD per day.
Forex trading is an international market that doesn’t have a central marketplace. Instead, currency is traded over-the-counter digitally. The forex market is open 24 hours per day, for 5 and a half days per week. During this time, currencies from around the world are traded within major financial centers such as New York, London, Zurich, Tokyo, Hong Kong, Frankfurt, Paris, Singapore, and Sydney. It includes nearly every time zone, meaning when the trading day ends for the U.S, it actually only starts in Hong Kong and Tokyo. This leads to the Forex market constantly being active, and quotes always changing.
Forwards, futures, and spot markets
When it comes to trading in the forex market, there are three ways to go about it: forwards market, futures market, or spot market. The spot market has been the largest market in forex trading since the beginning due to it being an “underlying” asset, which the forwards and futures markets depend on.
Futures market had been a very popular method for traders in the past as it was offered to individual investors for a longer time period. Although, when electronic trading became popular, there was a large increase in the spot market activity, which surpassed the futures market and became the preferred trading method for individual investors, as well as speculators.
Usually, when referring to the forex market, people are talking about the spot market. Forwards and futures markets are often more popular when it comes to companies looking to hedge foreign exchange risk to a future date.
What is the spot market?
The spot market is where currencies are bought and sold at the current price. It is determined by supply and demand and reflects various aspects, such as economic performance, interest rates, future performance perception of a single currency against another currency, and sentiment towards ongoing political situations, local and international.
Once deals are finalized, it’s referred to as a ‘spot deal,’ a bilateral transaction where one of the parties delivers the currency amount agreed on to the counter, then receives a certain amount in the other currency, all based on the agreed exchange rate values. Once positions are closed, the settlement is made in cash.
What are futures and forwards markets?
Where the spot market focuses on trading actual currency, the forwards and futures market have contracts with a future settlement date.
In the forwards market, contracts get sold and bought over-the-counter between two parties that agree on certain terms among themselves. In the futures market, futures contracts are sold and bought depending on standard sizes and the settlement dates for public commodities markets.
Both provide binding contracts that are usually settled for cash once expired. Additionally, forwards and futures markets can provide protection from the risk of trading currencies. Generally, large international corporations take advantage of these types of markets to hedge future exchange rate fluctuations.
Still have questions? Feel free to check out our ultimate guide on how to trade forex to learn the different ways to utilize trading strategies, avoid amateur mistakes, and maximize your income.