The 3 Ways in Which Forex is Traded

By: Justin Stewart

The trading done by individuals and institutions in the Forex market utilizes three different venues --- the forwards market, the futures market, and the spot market. Until fairly recently, the futures market was considered to be the "top dog" in that it made long-term trading available to all investors. However, with the intrusion of the internet into the currency exchange marketplace, and trades being made as simple as clicking one's mouse, the spot market has grown in leaps and bounds, surpassing the futures market for top spot.

Consequently, when investors and speculators refer to the Forex market, they are normally referring to the spot market itself. The forwards and futures is more the focus of the larger entities in the marketplace because they usually need to hedge their risks out to a specified future date.

The Forwards Market - the venue wherein forward contracts are usually traded in an over-the-counter manner. The fact that forward contracts are normally consummated privately between two parties negates their occurrence in the standard exchange venues. The term forwards market is used to specify the informal market wherein these contracts are entered and exited from.

No actual currencies are traded in the forwards market. Trading is done contractually wherein there are claims made to a specified type of currency with a pre-agreed upon price attached to it and a future date for settlement of the contract. As was previously mentioned, contracts between two private parties are purchased and sold in OTC fashion with the involved parties determining the terms of the agreement amongst them.

The Futures Market - this market involves an auction-type format wherein the parties involved purchase and sell commodities and futures contracts that are to be delivered on a specified date in the future, three months being the standard timeframe. Just like the stock market, trading is conducted in a "pit" that is oftentimes quite crowded, and witnessing trade commands either being shouted or conducted by virtue of hand signals.

When the stock market outlook becomes uncertain, the futures market benefits in that there is a noticeable spike in trading volume that occurs. It doesn't matter what the stock market does. In other words, whether bearish or bullish (moving downward or upward), there is no perceived impact within the Forex market.

The Spot Market - the venue wherein currencies are purchased and sold according to their current value (price). The price is ultimately determined by the economic factors of supply and demand, however, price fluctuations are also a reflection of the following:

* including current interest rates
* economic performance
* sentiment towards ongoing political situations (both locally and internationally
* the perception of the future performance of one currency against another

When a currency transaction is finalized, it is referred to as a spot deal and is a bilateral arrangement wherein one of the parties involved delivers a pre-agreed upon currency amount to the other party involved. In turn, the initial party then receives a pre-agreed amount of another currency at the agreed-upon value of the current exchange rate. Once the trade is complete and the position is closed, the settlement is paid in cash. And although the spot market platform is one that deals with present day transactions (rather than the future) trades in the spot market occur over a 48-hour period.

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