Investing for Beginners: What is Forex Trading?

Forex of FX stands for foreign exchange and a forex market is where currencies are traded. It’s important to everyone around the world as currencies need to be exchanged in order to enable foreign trade. As a result, Forex trading plays a major role in global trade.

The forex market is the largest financial market in the world and it’s also the most liquid. However, what’s unique here is the fact that there is no central marketplace for foreign exchange. All transactions are conducted electronically between traders around the planet.

As a result, Forex trading never ends, it happens 24-hours a day, five and a half days a week. This is primarily because of time zones where major financial markets are located. For example, when trading ends in North America, the forex market in Tokyo, Japan will start its trading day. This enables the 24-hour cycle for currency trading.

Where Do you Engage in Currency Trading?

There are three different ways to engage in currency trading:

  • Spot Market
  • Forwards Market
  • Futures Markets

The spot market is the largest market where one can trade foreign currencies. This is mainly because it’s the underlying real asset that the other two markets are based on.

The futures market used to be the leader when it came to popularity, but electronic trading has changed all that (bringing the spot market to the forefront). As a result, when investors talk about the forex market, they are usually referring to the spot market.

Forwards Market and Futures Market

Enterprises use futures and forwards markets a lot more as they need to hedge their foreign exchange risks on to a specific date in the future. These markets don’t trade actual currencies, instead, they basically represent contracts and claims to a certain type of currency (set at a specific price per unit at a future date).

These contracts are often bought and sold over the counter (OTC) between two parties that determine the terms of the agreement between themselves. In the futures market, these contracts are bought and sold based on the settlement and size on the public commodities market.

Key characteristics of futures contract:

  • Number of units being traded
  • Delivery date
  • Settlement date
  • Minimum price increments that cannot be customized

These contracts can be bought or sold and settled for cash upon expiry. When it comes to forex trading, it’s the futures and forwards markets that provide protecting against risk.