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The different ways of trading forex: Part 1

The different ways of trading forex: Part 1


Another interesting week in markets as the week comes to an end. We could see more volatility as $2.1 trillion option notional expires. Read below to find out more.

Traders have developed a wide range of methods for investing in or speculating on currencies as a result of how fascinating forex has emerged.

Retail forex, spot FX, currency futures, currency options, currency exchange-traded funds (or ETFs), forex CFDs, and forex spread betting are the most widely used financial instruments.

It’s vital to note that we are discussing the different methods of FX trading available to individual (“retail”) traders. Since they serve institutional traders, other financial instruments like FX swaps and forwards are not covered.

Now that that is out of the way, let’s discuss in part 1 how you can participate in the forex market.

Currency Futures

Futures are agreements to acquire or sell a specific assets at a predetermined price at a later period (hence the name “futures”). These “currency future” are contracts that specifies the price at which a currency might be purchased or sold and establishes a fixed date for the exchange.

The Chicago Mercantile Exchange (CME) formulated the currency futures way back in 1972, when the disco era and bell bottoms were go to trends of that time.

The futures market is relatively open and well-governed because futures contracts are standardized and exchanged on a single exchange. This implies that information on prices and transactions are easily accessible.

Currency Options

An “option” refers to a financial instrument that grants the buyer the right or the option, but not the responsibility, to buy or sell an asset at a given price on the option’s expiration date.

A trader would be required to buy or sell an asset at a certain price on the expiration date if they “sold” an option.

Options are traded on an exchange, such as the Chicago Mercantile Exchange (CME), the International Securities Exchange (ISE), or the Philadelphia Stock Exchange (PHLX), in the same way that futures are traded.

However, the disadvantage in trading FX options is that market hours are limited for certain options and the liquidity is not nearly as great as the futures or spot market.

Currency ETFs

An exposure to a single currency or a basket of currencies is provided by a currency ETF.

Currency Exchange Traded Funds (popularly known as Currency ETFs) make it possible for regular people to access the foreign exchange market through a managed fund without the hassle of making individual trades. Currency ETFs can be used to diversify a portfolio, speculate on foreign exchange, or protect against currency risks.

Financial institutions construct and administer ETFs that purchase and hold currencies in a fund. Once shares of the fund are made available to the public, individuals can purchase and sell these shared on an exchange much like stocks.

Like currency options, the market’s limited hours make trading currency ETFs more difficult. ETFs are further charged trading commissions and other transaction fees.

Spot FX

The spot FX market, commonly referred to as an over-the-counter (“OTC”) market, is an “off-exchange” market. This type of trading takes place in a sizable, thriving, and liquid financial market that is open around-the-clock. Because there is no central location to conduct trade or “exchange,” it is not a market in the conventional sense.

As an OTC market, customer are able transact directly with a counterparty. With that being said, the Spot FX market are over-the-counter contracts, as opposed to currency futures, ETFs, and (most) currency options, which are traded through controlled exchanges (private agreements between two parties).

Here, electronic trading networks constitutes a majority of trading (or telephone).

Here, the primary market for FX is called the “interdealer” market where FC dealers trade with one another. A dealer is a type of financial middleman that makes itself available to its clients at any time to purchase or sell currencies.

Due to banks’ predominance as foreign exchange dealers, the interdealer market is frequently referred to as the “interbank” market. Only very high net worth institutions with extensive trading operations are permitted access to the interdealer market.

Large financial institutions, such as banks, insurance firms, pension funds, enterprises, and other similar organizations, manage the risks related to fluctuations in the exchange rates.

An institutional trader in the spot FX market buys and sells an agreement or contract to make or procure delivery of a currency. A spot FX transaction is a bilateral agreement where two parties come into an arrangement to exchange one currency for another.

This agreement is legally binding. In other words, a spot contract is an agreement to buy or sell a certain quantity of foreign currency at the “spot exchange rate” or current exchange rate that legally binding.

As a result, when you purchase EUR/USD on the spot market, you are engaging in a transaction wherein a contract is made that states you will receive a particular number of euros in return for US dollars at a predetermined price (or exchange rate).

It’s crucial to note that you are trading a contract involving the underlying currencies rather than the underlying currencies themselves.

Despite being called “spot”, deals aren’t really concluded “on the spot.”

Spot FX trading is done at the current market rate, but the actual transaction does not settle until two business days later. This type of transaction is known as the T+2 which abbreviates to “Today plus 2 business days”

When the delivery of what you buy and sell takes place, it should be done within 2 working days and is referred to as the value date or delivery date

For example, suppose the financial institution conducts its transactions in a spot market, the trade is opened and closed on Monday generates its value date on Wednesday which in turn results in it receiving the Euros on Wednesday.

However, not all currencies settle T+2. For instance, the value date for USD/CAD, USD/TRY, USD/RUB, and USD/PHP is T+1, or one business day from today (T).

The value date or delivery date refers to the need that you deliver the goods you buy or sell within two business days.

As an illustration, a company purchases EUR/USD in the spot FX market.

Retail traders DO NOT, however, trade on the actual spot FX market.

In part 2 of “The different ways of trading forex” we will provide a detailed description on the other ways forex trading takes place.

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