The foreign exchange market (FX or Forex for short) is among the most fast-paced and exiting markets in the world. Forex trading within the currency market, until recently, had been reserved for very wealthy individuals, hedge funds, central banks, corporations and large financial institutions. This has all changed with the emergence of the Internet and technology. Average investors now have the opportunity to easily buy and sell currencies through just the click of one mouse via online brokerage accounts.
Usually daily currency fluctuations are very small. A majority of currency pairs move less than a percentage point per day. This represents less than a 1% change in a currency’s value. That makes foreign exchange among the least volatile of all financial markets. Therefore, a majority of currency speculators rely on the high amount of leverage that is available for increasing potential movement value. Leverage can be as high as 250:1 within the retail Forex market. High leverage can be very risky. However, due to deep liquidity and round-the-clock trading, foreign exchange brokers have successfully made high leverage a standard within the industry so that currency traders can have meaningful movements.
Extreme liquidity and high leverage being widely available have helped with spurring the rapid growth of the market and transformed it into an ideal place for numerous traders to invest. Positions can be held for many months, opened and closed in just a couple of minutes, or somewhere in between. Supply and demand considerations form the basis of currency prices. They cannot be easily manipulated due to the fact that the market is so large that not even the biggest players, like central banks, are able to move currency prices at will.
There is lots of opportunity provided by the Forex market for investments. However, a currency trader must have a good understanding of the basics that are behind movements in currency in order to succeed.
The goal of our Forex tutorial is providing a foundation for traders or investors who are just getting started with the foreign currency markets. We will be covering the history of the market, exchange rates basics and the key concepts that are important for you to understand so that you can get involved with the market. We will also be covering how you can get started trading foreign currency as well as the various kinds of strategies that you can use.
The foreign exchange market is where foreign currencies are traded. To a majority of individuals around the world, currencies are very important. It is due to the fact that currencies must be exchanged to conduct business and foreign trade. If you live in the United States and would like to purchase cheese from France, either the company you are purchasing the cheese from or you will need to pay for this cheese in euros (EUR). What that means is the equivalent U.S. dollars (USD) value would need to be exchanged for euros. For traveling, the same thing is true. When a French tourist travels to Egypt he would not be able to pay in euros for seeing the pyramids since it isn’t the currency that is locally accepted. The tourist will need to change his euros, at the current exchange rate for the Egyptian pound.
The need for exchanging currencies is the main reason why the foreign exchange market is the world’s most liquid and largest financial market. All other markets are dwarfed in size compared to it, including the stock market. It has an average daily traded value of $2,000 billion USD.
One unique aspect that the international market has is that foreign exchange trading does not have a central marketplace. Instead, currency trading takes place electronically over-the-counter (OTC), meaning that all transactions take place between traders all over the world via computer networks, instead of through one centralized exchange. This market is open 5 1/2 days per week, 24 hours per day. Currencies are traded on a worldwide basis in all of the major financial centers, including Paris, Sydney, Singapore, Frankfurt, Hong Kong, Zurich, London, New York and Tokyo- across nearly every time zone. What that means is that when the U.S. trading day is ending, the Forex market is starting again in Hong Kong and Tokyo. The Forex market has the potential to be very active at any time during the day, and prices quotes change continually.
The Futures And Forwards Markets And The Spot Market
There are three ways that individuals, corporations and institutions trade Forex: the futures market, the forwards market and the spot market. The largest market has always been Forex trading within the spot market since it is the “underlying” real asset forming the basis for the futures and forwards markets.
For traders, the futures market in the past was the most popular trading venue since it was available for a longer time to individual investors. However, the rise of electronic trading has resulted in the spot market enjoying a large surge in activity. It has surpassed the futures market and for speculators and individual investors is now the preferred trading market. Usually people refer to the spot market when talking about the Forex market. The futures and forwards markets have a tendency to be more popular among companies needing to hedge foreign exchange risks to a future specific date.
The Spot Market Defined
The spot market, more specifically, is the place where currencies are purchased and sold at the current price. The price, which supply and demand determines, reflects a number of different things, including economic performance, current interest rates, feelings about ongoing political situations (internationally and locally), and perception of what future performance will be in terms of one currency versus another. Whenever a deal has been made final, it is called a “spot deal.” This is a bilateral transaction where an agreed-upon amount of currency is delivered by one party to the counter party and gets a specified amount of a different currency at the exchange rate value that has been agreed upon. After the position has been closed, cash is used to settle it. The spot market is known for dealing in the present with transactions (as opposed to the future), it can take two days for the trades to settle.
What Are The Futures And Forwards Markets?
The futures and forwards markets, unlike the spot market, don’t trade actual currencies. They deal instead in contracts representing claims to a specific type of currency, a specific per unit price, and future settlement date.
On the forwards market, two parties buy and sell contracts OTC, with the terms of agreement being determined between them.
On the futures market, the purchasing and selling of futures contract are done based on the settlement date and standard size on public commodities markets, like the Chicago Mercantile Exchange. The National Futures Association, in the U.S., is responsible for regulating the futures market. There are specific details to futures contracts, including minimum price increments that you can’t customize, settlement and delivery dates and number of units traded. The exchange provides clearance and settlement for traders.
Both kinds of contracts are binding. They usually are settled for cash at the specific exchange upon expiry. However, it is also possible to purchase and sell contracts before they expire. The futures and forwards markets offer protection against trading currency risk. Large international corporations usually use the markets to hedge against exchange rate future fluctuations. However, speculators also participate in those markets.
Note that you will also encounter the following terms: currency market, foreign exchange market, Forex and FX. Those terms are all synonymous and they all refer to the Forex market.