Forex market is a varied platform in which the participants buy and sell currencies. It consists of banks and other financial institutions. It is not domestic to a country. It involves global players. We have to trade on the bid and ask prices for currency pairs. Let us read and understand some specific concepts about forex trading.
What makes forex trading unique?
- There are two different markets. The interbank market where we have large banks and financial institutions participating to preserve themselves against hedging and other adjustments. The other one is Over-the-counter, wherein we have individuals trading using different platforms of their choice.
- As it involves countries throughout the globe, we do not have a time frame unlike the other markets such as equities and commodities. The trading 24 hours a day.
- It is considered one of the highly traded markets compared to the equity and futures market. The reason is primarily that we have currencies that need to be exchanged at any point in time. For any transaction, for buying any product, for companies to get raw materials, we need to transact in different currencies. This makes it very important and inevitable. And also there is no specific marketplace for foreign exchange.
Three ways of trading
There are basically three ways in which trading actually happens, namely the spot market, the forwards and the future market.
The spot market functions basically based on the current price of the currencies. This means currencies are bought and sold based on the current prices. These prices are further determined by the interest rates, economic conditions, financial crises, market supply, and demand. The finalized deals called the spot deal. I this bilateral transaction, we have one party giving a currency to the counterparty and receives another currency at the current value of the exchange rate.
In the forwards or the future market, we do not see parties trading on actual currencies. Rather they work on contracts that are entitled to a currency, a specific price per unit and a future date for settlement. In the futures market, we have deals happening in the public markets and exchanges based upon a standard settlement date. It has specific details, such as the units being traded, price, delivery date and the settlement date. The exchange serves the purpose of a counterparty and provides clearance for the settlement. In the forwards market, however, we have the contracts decided between the individuals over the counter. The terms and conditions are based on their mutual agreement.
If an individual is well versed with the economic situation in the world and can understand and predict currency devaluation it is good to invest and trade in forex. When our portfolio is overexposed to a single currency, we can diversify using this strategy of investment. A small movement in the currency can make large profits and currency appreciation beyond expectations. Practice and place safe exchange trades and reap save benefits as it is highly challenging.