Below is a guest post from Mr. Zahir from MTrading India. It is good to get other people’s explanation of trading Forex, which may give the reader a better understanding coming from a slightly different angle. Enjoy!
Basically, you can trade in the forex market via 3 ways: the forwards market, futures market, and spot market, with the spot market being the largest among the three. For one, the underlying asset that futures and forwards trading are based on the spot market assets.
The futures market used to be the most popular market in the past simply because of the fact that it had been made available to individual traders for a long time – before individual investors gained access to the spot market. However, with the advent of electronic or online trading, the spot market experienced a sudden surge in popularity, particularly with speculators and individual investors. In no time, it surpassed the other markets in terms of size and popularity.
The Spot Market
Simply put, this is the market where you can buy and sell currencies based on the prevailing rates, which are dictated by supply and demand. Various factors, in turn, affect supply and demand including the current political climate (both locally and internationally), economic performance, interest rates, and a particular currency’s expected performance against another.
A finalized transaction is called a “spot deal,” a bilateral deal whereby one party delivers the agreed amount of currency to another, and in turn receives the corresponding amount in the counter currency based on the agreed exchange rate. Positions are closed with cash settlements. While the transactions are generally considered as current or in the present time, the actual settlements can take up to two days.
The Forwards Market and the Futures Market
The futures and forwards markets, unlike the spot market where actual currencies are traded, involve contracts between two parties representing claims to a specific currency. The currency is stated at a given unit price that is to be settled at a future agreed date.
Forwards contracts are sold and bought over the counter, with the terms determined by the contracting parties. On the other hand, a futures contract is sold and bought based on standard sizes and settlement dates. Transactions are regulated by the National Futures Association.
Futures market contracts contain specific details such as the number of traded units, settlement and delivery dates, and the fixed minimum price increments. The exchange serves as the trader’s counterpart that provides clearance and settlement.
Both forwards and futures contracts are binding and closed with cash settlements upon maturity, although a contract may be sold or bought before its expiry date.
Both types of contract can provide some form of risk protection in currency trading. In many cases, the futures and forwards markets are used by large international companies as a hedge against fluctuations in future currency exchange rates. There are cases, however, when speculators trade in these markets too.
Reference: Author of the article is Mr. Zahir from MTrading India