Types of FOREX Markets
There are various types of FOREX markets you can choose to invest in. Depending on your expectations, experience, and interests, you can choose to invest in any of these markets. The best part of all is that you can dip your toes into all markets at the same time. However, we don’t recommend this right away. It’s always best to master one market before moving on to the next. Eventually, you’ll be able to make money in various types of markets at the same time.
Also, please keep in mind that understand how each market works is both a question of practice and experience. So, it’s always a good idea to study the dynamics of each market. That way, when you are set to market some money, you know what to expect. Moreover, you’ll be ready for anything that might come your way.
The Spot Market
By far, this is the most common market within the FOREX domain. The reason why it’s called “spot” it’s because the transactions which take place in this market happen at the current exchange rate. Please bear in mind that exchange rates vary all the time. Therefore, you need to keep a close eye on where they are heading. Since exchange rates are determined by market forces, they can shift significantly in a short time period.
In FOREX, “exchange rates” refer to the relative value on one currency to another. This means that exchange rates express how much one currency is worth with regard to another. As such, you may find that exchange rates function as a price when conducting trades. Depending on the movement of exchange rates, you can make or lose money.
The majority of the action happens in the spot market. This means that the largest volume of trading happens among currency pairs as they are traded based on current exchange rates. The degree with which trading volume increases or decreases is called “volatility.” Volatility refers to the changes in the volume of trading. If the volume of trading doesn’t change much, then there is little volatility. However, if there are sudden changes, then this would be considered volatility.
Additionally, volatility refers to the fluctuations in exchange rates themselves. When there is a high degree of volatility, there are significant shifts in exchange rates. Often, these shifts are nothing more than pennies on the dollar. Still, when multiplied by thousands, or even millions of dollars, the pennies suddenly add up. Therefore, it’s important for you to keep this in mind.
When you set out to trade on the FOREX market, you will find that your trading platform will display exchange rates as they are being calculated through the act of supply and demand. Supply refers to the amount of one currency available on the market, while demand refers to the number of buyers who wish to purchase it. When there is a balance among these two forces, exchange rates remain relatively stable. When there is a significant shift on one side or another, then exchange rates may suddenly swing up or down.
While violent swings in exchange rates are not unheard of, they are uncommon unless there are forces that compel investors to dump one currency and seek refuge in another.
Consider this situation:
Investors are loading up on the currency of country X. This causes supply to be in short order as more and more investors are interested in taking positions in this currency. Then, country X announces they have been hit severely by falling oil prices, causing them to default on their external debt. This causes investors to panic and begin dumping their positions in this currency. Since investors are now looking to find shelter, they begin to dump currency X and buy US Dollars. This causes the relative price of the US Dollar to go up in relation to currency X.
This example might seem a bit extreme, but it has happened throughout history. So, it’s not uncommon to see such situations, especially in countries that don’t have a stable political situation. As we will discuss later on, it’s important for investors to be cognizant of a country’s political stability and economic outlook. These are the main factors that can help you determine if you are getting into a safe deal, or you might be opening up yourself to unwanted risk.
The futures market, as the name implies, deals with transactions that will be completed at some point in the future. The futures market is governed by contracts between buyer and seller. In these contracts, the seller agrees to sell at a specific exchange rate while the buyer agrees to purchase at that specific exchange rate.
These contracts are conducted for two main reasons:
The first reason, both buyer and seller are concerned about volatility. As such, they are keen on making sure that they can lock in a given exchange rate so they can avoid having to pay a higher rate or having to sell at a lower one. This is done for purely speculative reasons. Now, it should be noted that not all futures contracts create an obligation to either buyer or seller. In fact, some contracts are called “options.” Under the concept of an option, investors can choose not to buy or sell under the specific terms of the contract itself. These provide a great deal of flexibility, especially when volatility is quite high.
The second reason is related to supply. There are times when investors foresee the possibility of shortages in the supply of a currency. So, they might take out a futures contract in order to ensure that they have a guaranteed supply of a specific currency. Later on, these contracts can be sold to other investors who are looking to ensure the supply of a given currency. In such cases, you would not be profiting from the sale of the currency itself. Rather, you would be profiting from the sale of the contract.
Lastly, the futures market is a very important part of FOREX, as it allows investors to protect their positions in the long run. This is a clear difference from the spot market, as the spot market mostly deals with short-term deals. In contrast, the futures market deals with trades that may be conducted months into the future. It all depends on the specific terms of the contract itself.
In the forward market, the transactions that occur are generally the same as the futures market, with the difference that the terms and conditions are customizable to suit the needs of the investors. As such, any number of conditions can be used to trigger the contract. The most common condition is time. The contract would have a specific expiration date in which the trade is executed one the deadline is reached. Also, contracts may include very specific conditions such as exchange rates, volatility, and even the number of trades placed. For instance, a forward contract may stipulate that if the two parties engage in five trades over a two-week period, then the forward contract is executed, thereby causing a sixth trade to happen.
This example highlights how conditions can be set up to meet any number of needs so long as the parties involved agree to them. This offers a great deal of flexibility that cannot be found in the spot market. So, do keep this in mind as you may find yourself in need to engage in custom deals, especially if you can find a willing trade partner.