Many people believe that their normal lives will never be affected by the currency rate, but this is not so. Foreign currency exchange is required to carry out business and trade between the different countries. The foreign currency rate of a country affects its citizens as it affects the price of imports.
This financial market is unique in that it is a decentralised market which works on an interbank system. Currency trading is done electronically which means that all the transactions are carried out by electronic means through large financial institutions and banks. The market does not operate through a central exchange as the stock market does. The forex market trades day and night during the business week. This day/night trading time period makes it an extremely active market which is the cause of the movements in currency prices.
Trading Markets Related to Foreign Currency Exchange
Corporations, individuals and financial institutions trade in three basic ways in this market. This is through the spot, futures and forwards markets. The futures and forwards markets are based on the spot market, which makes the spot the largest of the three. The futures market was once the most popular market because individual investors had the opportunity to trade on it for longer periods. With the introduction of electronic trading, the spot market has become the market of preference for traders. When forex traders refer to the trading market, they are referring to the spot market. The forwards and futures markets are more popular with corporations who need to hedge against price movement risks.
This market is where the different currencies are bought and sold at the current market price. The prices which are based on supply and demand are affected by events such as political stability, economic trading, interest rates and the perception of the rate of one currency to another currency. A ‘spot deal’ is when a deal has been finalised on the spot market. This deal comprises of a two-way decision where one entity sells a certain amount of a currency to another entity for a specified amount of another currency, at a rate that is mutually agreed upon. The settlement for the deal is done in cash as soon as the position has been closed. This market may deal with present instead of future trades, but it still takes up to two days for the full and final settlement of the deal to occur.
There are specified details that relate to futures contracts, such as the settlement and delivery dates, the minimum price increases and the quantity of units that the parties have agreed to.
This market comprises of the purchasing and sale of contracts between two entities who have agreed on the terms of the contract to buy and sell currencies at a specific rate on a specific date.
Both the futures and the forwards contract are binding and final and are normally bound by the cash settlement for the agreed amounts as specified in the contract. The contract may be bought and sold before the expiry date stipulated.
These are the main trading markets in the forex trading market and they are used for specific deals.