Do you think the Forex market is entirely different from the stock and commodity markets? Well, though the style of trading may be quite different, the ways to trade the Forex market is almost the same. In the stock market, there is stuff like stock futures, stock options, and stock ETFs. On the same line, Forex, too, has currency futures, options and ETFs. Well, so let us discuss each one of them in detail.
What are the different types of Foreign Exchange Markets?
There are four major foreign exchange markets.
- Spot markets
- Futures markets
- Options markets
- Exchange-traded Funds
Here, Futures and Options are called derivatives because they derive their value from underlying exchange rates.
Spot Forex Market
As the name quite suggests, in the spot market, currency pairs are traded on the spot (immediately) using the current market price (CMP). Also, trading in this market is pretty simple and convenient because of its liquidity, tight spreads, and 24 hours operations. Moreover, nowadays you can participate in the spot market with as little as $50 in your account. This is the market where most retail traders take part in, as the brokers provide them with real-time charts and news for free.
In a more technical language, the spot market is the market where transactions for buying and selling currency are performed for immediate delivery, where it takes one or two days to settle these transactions.
Some of the major participants on the spot exchange market are:
- Commercial banks,
- Brokers, Dealers,
- Arbitrageurs and speculators, and
- Central Banks
The Currency Futures were launched on the International Money Market (IMM) at Chicago in the year 1972. The futures market is one of the rapidly-growing markets since its launch.
Futures are contracts, which basically is a commitment to buy or sell a currency on a specific future date at a particular price on the date mentioned on the contract. Unlike the spot market, a futures contract is executed at a later date. This is the reason they are called futures.
As futures contracts are traded on a central exchange and are well standardised, this market is transparent and appropriately regulated.
Currency Options is a financial instrument that gives its Option holder a right (or an option), but no obligation to buy or sell a currency sometime in the future.
For example, if a person buys an Option contract, this contract gives the buyer a right, and not an obligation – to buy or sell a certain amount of a currency at a fixed price in advance. The right the buyer has can be exercised either at an established maturity date or during the period up to maturity date.
The newly emerging market in the world of Forex is the Exchange-traded Funds.
An ETF is a type of fund that keeps a track on a single currency or usually a tub of currencies. These ETFs are managed by financial institutions that buy and hold currencies in that kind of funds. These funds are then offered to the public on an exchange board in the form of a share, allowing them to buy and sell these shares just like any other stock.
Finally, when we discuss Forex Trading in the following articles, we’ll be specifically talking only about the spot forex market.