There are several ways to speculate in the currency market and several financial instruments are available to traders.
The most popular ones are:
1. Retail forex
2. Spot FX
3. Currency futures
4. Currency options
5. Currency exchange traded funds (ETFs)
6. Forex contracts for difference (CFDs)
7. Forex spread betting
Mainly, we will talk about the ways that retail traders — that refers to individuals like you and me — can trade FX. Institutional traders have a variety of other financial instruments at their disposal that are especially catered to them, such as FX swaps and forwards.
Retail Forex
This is where individuals like you and me typically play ball. Forex trading providers give retail traders access to the currency market through the primary OTC market. They find the best available spot prices and then add a mark-up before showing the prices on their trading platforms. These forex trading providers are usually known as forex brokers. No one takes delivery of any currency in forex trading. Especially in the retail forex market. Retail forex traders cannot take or make delivery on leveraged spot forex contracts.
Leverage essentially permits retail traders to control large amounts of currency for a very small amount. Retail forex brokers allow you to open positions valued at 50 times the amount of the initial required margin — which is called leverage. So, for example with $1,000 account, you can open a USD/JPY trade valued at $50,000. It is unrealistic to think that you would have to deliver $50,000 worth of physical currency in a trade. You couldn’t settle the contract in cash because you would only have $1,000 in your account, lacking the funds to cover the transaction. So, retail traders either must close the trade before it settles or roll it over. This is how retail traders avoid the obligation to accept or deliver $50,000 worth of physical currency.
Retail forex transactions are closed out by entering into an equal but opposite transaction with your forex broker. For example, if you bought Swiss francs with U.S. dollars you would close out the trade by selling Swiss francs for U.S. dollars — also called offsetting or liquidating a transaction. All positions would be automatically rolled over to the next value date if that position was left open at the close of the business day. In fact, the position would automatically continue to be rolled over indefnitely until it is closed. That process of rolling over a position is known as tomorrow-next which stands for tomorrow and the next day. When trades are rolled over, interest is either paid or earned by the trader known as a swap fee or rollover fee. Your broker will either debit or credit your account balance in the event of a rollover. At the end of the day, it is all speculative.
Retail forex trading means traders are speculating or essentially making bets on and profiting from the fluctuation in exchange rates, not looking to take physical possession of the currencies they buy or deliver the currencies they sell.
Spot FX
The spot FX market — also known as an over the counter (OTC) market — is an off-exchange market. Trading in the spot FX market is not where regular retail traders trade. Usually, the spot FX market is for institutional traders that are buying and selling currencies through an agreement or contract.
In an OTC market, the two parties to a trade are directly linked. In other words, unlike currency futures, ETFs and most currency options which are traded through centralized markets, spot FX are private agreements between two parties — often conducted through electronic trading networks.
The main market for FX is the interdealer market where dealers trade with one another. That dealer is essentially a fnancial intermediary that is ready to buy or sell currencies with its clients. Also known as an interbank market due to the dominance of banks as FX dealers, the interdealer market can only be accessed by institutions that trade large volumes and can swing large amounts of money. Examples include banks, insurance companies, pension funds, large corporations, and other institutions.
Currency Futures
If you have ever messed around with stocks, or commodities, then you might know what a future is. Essentially, futures are contracts to buy or sell a certain asset at a specific price on a future date.
In terms of currencies, a currency future is a contract that lays out the price at which a currency could be bought or sold and outlines a specific date for that exchange. These types of contracts are common and standardized — and traded on a central exchange with the market being very transparent and regulated.
Currency Options
A financial instrument that gives buyers the right (but not the obligation) to buy or sell an asset at a specific price on an expiration date is called an option. For example, if a trader sold an option, they would be obligated to buy or sell an asset at a predetermined price when the expiration date arrives.
It’s worth noting that there is a distinct disadvantage in trading FX options — and that is the market hours. The times available to execute certain options are limited and the liquidity is not as desirable as it is in the futures or spot markets.
Currency ETFs
A currency ETF offers exposure to a single currency or basket of currencies. They are typically an investment vehicle, much like a mutual fund or other basket of assets.
ETFs are created and managed by financial institutions. They offer shares to the public on an exchange. However, like options the limitation in trading currency ETFs is at the market has limited hours and they are subject to trading commissions and other transaction costs.
Forex CFD
CFD stands for contract for difference and is a financial derivative. These derivatives follow the market price of an underlying asset so that traders can speculate on whether that price will go up or down.
A CFD is a contract between a trader and a CFD provider where one party settles with the other on the difference in the value of a security between the opening and closing of the trade. Basically, it is a bet between two parties on the price of a particular asset going up or down in value and whoever wins the bet will pay the other the difference between the assets price when you enter the trade and when you exit the trade.
If you trade Forex CFDs, you can trade a currency pair both long and short. Then, if the price moves in your chosen direction, you will have a profit, and if it moves against you, you will have a loss.
Forex Spread Bet
There’s a derivative product called spread betting, where traders are not taking ownership of the asset but instead speculating on which direction they think the price will move.
A spread bet allows traders to speculate on the price direction of a currency pair in the future. Profit or loss is determined by how far the market moves in the trader’s favour before closing the position and how large their position is.
This kind of speculation is offered by spread betting providers, but unfortunately in the United States spread betting is illegal. It is considered Internet gambling which is currently forbidden in most jurisdictions.
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