Forex exchange basically stands for foreign exchange. That means the foreign exchange market is the “place” where people trade currencies. Currencies are important to a lot of people around the world, whether they know it or not. You see, currencies need to be exchanged in order to conduct foreign trade and business. Let’s say you own your very own restaurant and would like to order some very exotic cheeses from France. Either you or the company you buy the cheese from has to buy it from France in euros. When traveling you need to do the same, our rand has no value to France. The reason being, they don’t use the rand as currency in France.
The need to exchange different currencies is the reason why the forex market is the biggest and most liquid financial market in the entire world. Comparing other markets to forex trading is like comparing the sun to earth, there is just no comparison. That’s because the total value of all trades done in forex is about $2 000 billion a day. This amount changes every day and goes up to $7 trillion per day and higher.
A very unique aspect of the international market is that there is no central marketplace, all trades in forex are done electronically via computer networks between traders around the world. This is also known as over-the-counter (OTC). The market is open 24 hours every day for 5 and a half days a week. These currencies are then traded worldwide in all the major financial centers of London, New York, Tokyo, Zurich, Hong Kong, Frankfurt, Sydney, Singapore, and Paris (the place you’re buying your cheese from). So when the trading day ends in the U.S.A, the forex market begins anew in Tokyo and Hong Kong, that’s why the forex market can be very busy at any given time of the day.
There are in fact three ways for corporations, institutions and individuals to trade forex:
Forex trading in the spot market has always been the largest market because it is the “underlying” real asset that the forward and futures markets are based on. The futures market use to be the most popular in the past, because it was available to individual investors for a large period of time. Now that there is electronic trading, the spot market gained a huge sum of activity and surpassed the future market as the preferred trading market for speculators and investors. When people now refer to the forex market, it usually points to the spot market. The futures and forwards markets are now mostly popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.
To be more specific, the spot market is where currencies are bought and sold according to the current price and as always, the price is determined by supply and demand. Technically, it’s a reflection of many things, including current interest rates, economic performance, sentiment towards ongoing political situations (locally and internationally), as well as the perception of the future performance of one currency against another. So when a deal is finalised, it’s known as a “spot deal”.
When you think about it, it’s a bilateral transaction. As one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, the settlement will then be in cash. Even though the spot market is commonly known as one the deals with transactions in the present (not in the future), these trades takes up to two days for the settlement.
The futures and forwards markets do not trade actual currencies. They do trade in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement.
In the forwards market, contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves.
In futures market, futures contracts are bought and sold based on the standard size and settlement date on public commodities markets, like Chicago Mercantile Exchange. In the U.S.A, the National Futures Association regulates the futures market. These future contracts have specific types of details, including the number of units being traded, settlement dates and delivery, plus the minimum price increments that cannot be customised. The exchange acts as a counterpart to the trader, providing settlement and clearance.
Both of these types of contracts are binding and are typically settled for cash for the exchange in question upon expiry, some contracts however can be sold before they expire. The futures and forwards markets can offer protection against risk when trading currencies. Big international corporations usually use these markets in order to hedge against future exchange rate fluctuations, speculators also take part in these markets.
Take a look at the number one rated forex trading platforms in South Africa and start trading in forex today.
Quick note: When you see terms like – FX, Forex, forex exchange, foreign-exchange market or currency market. These terms are all the exact same thing.