The difference in Forex markets

The difference in the spot and futures forex markets

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There are actually three ways in which institutions, companies and individuals trade foreign exchange:

  •     The spot market
  •     The forward market
  •     The futures market

Foreign exchange trading in the spot market has always been the largest market because it is the "underlying" real asset on which the forward and futures markets are based. In the past, the futures market was the most popular trading venue for traders because it was available to individual investors for a longer period of time. However, with the advent of electronic trading and numerous forex brokers, the spot market has taken off tremendously and now surpasses the futures market as the preferred trading market for individual investors and speculators.

The forward and futures markets tend to be more popular with companies that need to hedge their foreign currency exposure until a certain date in the future.

Spot Market

More specifically, the spot market is a market where currencies are bought and sold according to the current price. This price, which is determined by supply and demand, reflects many things, including current interest rates, economic performance, sentiment towards the current political situation (both local and international), and perceptions of the future performance of one currency against another.

When a transaction is entered into, it is referred to as a "spot transaction". It is a bilateral transaction in which one party delivers an agreed amount of currency to the counterparty and receives a specified amount of another currency at the agreed exchange rate value. After a position is closed, settlement is in cash. Although the spot market is commonly known as a market where transactions are settled in the present (rather than the future), these transactions actually take two days to settle.

Unlike the cash market, forward and futures markets do not trade actual currencies. CFD in has a lot of similarities to these markets.Instead, they trade contracts that represent claims on a specific type of currency in , a specific price per unit and a future date for settlement.

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Futures Market

In the futures market, contracts are bought and sold OTC between two parties who set the terms of the agreement between themselves.

In the futures market, futures contracts are bought and sold based on a standard size and settlement date on public commodity markets, such as the Chicago Mercantile Exchange. In the United States, the National Futures Association regulates the futures market. Futures contracts have specific details, including the number of units traded, delivery and settlement dates, and minimum price increases that cannot be adjusted. The exchange acts as a counterpart to the trader provides clearing and settlement.

Both types of contracts are binding and are usually settled for cash on the relevant exchange at expiry, although contracts can also be bought and sold before expiry. The forward and futures markets can provide protection against risk in foreign exchange trading. Typically, large international companies use these markets to hedge against future exchange rate fluctuations, but speculators also participate in these markets.

Note that you will often see the terms: Foreign exchange market, Forex market, FX market and currency market. These terms are synonymous and all refer to the foreign exchange market.

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