Aspects Of Currency Trading
A unique aspect linked to the currency trading market is that it does not have a central marketplace. Regular stocks trade on stock exchanges, such as the New York Stock Exchange. Trading in this financial marketplace takes place electronically between traders and not on a central marketplace.
Spot, Futures and Forwards
There are three main methods that individuals, corporations and institutions use to trade. These are the futures market, the forwards market and the spot market. The spot market is the largest one of the three. The other two markets are based on the spot market.
The spot market is where the buying and selling of foreign currencies at the current price takes place. The price in this market is determined by economic law of demand and supply. There are other factors that determine these rates, such as:
- Economic situation of countries
- International and local political climates
- Current interest rates
- The future performance of currencies, based on perception
Once a deal is completed in this market, it is known as a ‘spot deal’. This involves a two-way transaction where one party sells a certain amount of currency and in return received a specific value in an alternate currency. The spot market is often thought of as immediate trades, however, it could take about two days to settle any trades.
Forwards and Futures Currency Trading Markets
These markets do not operate like the spot market. The trades are agreed upon for a specified date in the future. Rather than buying current price currency and receiving it immediately, these contracts gives the buyer the opportunity to lock a particular currency type, price and specify a future date for delivery.
The forwards market allows two parties to buy and sell contract over the counter, at predetermined agreement clauses between them. Futures contracts are based on standard sizes and delivery dates, and the buying and selling takes place on an exchange, such as Chicago Mercantile. In the U.S. this market is regulated by the National Futures Association. These contracts contain specific details, such as the delivery dates, settlement dates, minimum price movements and number of units. Both these contracts are binding on the parties. These contracts are to be settled in cash on the date of expiry, or it can be sold or bought prior to the expiry date, upon agreement by both parties. The exchange is involved in the settlement and clearance of contracts.
Speculators are able to participate in all these markets. The futures and forwards market reduces the risk of currency exchange. To illustrate this, imagine company X that is based in the United States, agrees to sell equipment for €100 million. If the euro loses its value during the contract period, it will not be worth as much when the time comes for conversion. Using the futures and forwards market, the corporations involved in this deal could hedge against currency fluctuations in the future. The company X could choose to enter into a contract to accept the euro value at an acceptable rate at some point in the future. This will prevent any losses for both companies as they will be happy to accept the rate they can agree upon for the future.