Fx trading is trading within the global, decentralized market of currencies. If you’ve ever heard the term, “foreign exchange market,” that’s what Fx is. This market contains the exchange of currencies worldwide. Banks, institutions, and even regular people can use the market to exchange their currency for that of a foreign nation. This exchange of currency allows for foreign trade, which makes the market incredibly important to the global economy. How does the Market Work? Fx Trading does not take place in one specific area. Instead, the trading occurs through a variety of websites and networks. Still, all currency exchange is considered part of the market. Within this one market, there are 3 separate markets for currency exchange. These markets are the Spot, Forward, and Futures Markets.
In each of these markets, one party attempts to buy or sell a set amount of currency based on the current exchange rate. For example, you may try to sell 35 of your US dollars for however many Japanese Yen that will buy you. Or, you could look to buy a set amount of Yen with however many US dollars it takes. Banks, businesses, and other institutions use this market regularly to stock up on whatever foreign currency they need. Still, the three separate markets work slightly differently.
The spot market is currently the most popular market for trading currency. This popularity is because the spot market deals in concrete transactions. Currencies, for example, are bought and sold on the spot market. The transactions function as a bilateral transaction in which one party exchanges a set amount of currency with another at the current exchange rate. Settlements, which typically take two days to finalize, are made in cash. The spot market is a quick way for investors to exchange their currency for another.
Forwards and Futures Markets
Neither of these markets deal in cash, unlike the spot market. Instead, investors buy and sell contracts, which act as claims to certain currencies. A specific settlement date is listed in the contract.
In the forwards market, contracts are bought and sold over-the-counter, or on the OTC market. The exchanges are agreed upon between the two interacting parties.
The futures market also uses contracts to agree upon standard sizes of currencies and settlement dates. It works very similarly to the futures market, although it deals more with public commodities markets. Furthermore, in the U.S., the futures market is regulated by the National Futures Association. The regulation ensures that the details of these contracts are specific. The minimum price increments, for example, cannot be controlled by the individual parties.
In both the forward and the futures markets, investors can enjoy some degree of protection against risks. Large international corporations use these two markets to protect themselves against future exchange rate fluctuations.
Fluctuations and Risk
On a small scale, this market is probably one of the least volatile markets around the globe. The sheer size of the trading means that even the largest banks and corporations can’t manipulate exchange or interest rates. As a result, rates tend to fluctuate within 1% of the original value.
This 1% fluctuation is rather safe for those who do not use leverage. Some, however, are attracted to risk and the prospect of huge gains. There is an immense amount of leverage available in this particular market. Investors can invest only $1,000 and borrow enough to control $100,000 of capital. In these cases, 1% fluctuations could result in thousands of dollars of profit or loss. Most traders, though, take advantage of the safety of the market and do not use leverage.
Currency trading is an important aspect of our global economy. Luckily, this market is so expansive and safe that foreign exchange, investment, and trade continue to skyrocket. So, as a simple summary, fx trading is the buying and selling of currency.