Forex is a word that is used when describing the foreign exchange market. It is the market where currencies are traded. Currencies are important to anyone who intends to conduct business across international borders. For instance, if you want to buy that is found in Britain while you live in the US, you will need to pay the British for the toy in pounds.
Consequently, the importer will have to convert US currency into a value that is equal to that of the toy in British pounds. That goes for those who are traveling. If you are going to China, you will need to pay in the local currency to enter the area where the local attractions are found. Thus, you will have to exchange your US dollars for the Chinese currency. This conversion will have to be done at the current exchange rate.
The need for the exchange of currencies is the reason why the foreign exchange market exists. Today, it is the largest and most liquid market on earth. It has a trade value of about $5 trillion daily. That is much bigger than the stock market, which has average daily volumes of about $2 trillion.
A unique aspect of the foreign exchange market is that there is no central trading market. Rather, trade takes place electronically over the counter. Thus, all transactions take place via computer networks throughout the world. The market works 24 hours a day for five and a half days of the week.
The Spot, Forwards, and Future Markets
Individuals or corporations can trade in the foreign exchange market in these three ways. The spot market is the largest one on which the other two are based. Companies that want to hedge their risks to a certain point in future are the ones that mainly use forwards and futures markets.
The Spot Market
This is the place where currencies are bought and sold according to what they are worth right now. The price, which is mainly determined by supply and demand, is a reflection of many other factors. A deal in the spot market usually takes two days to settle.
Forwards and Future markets
These markets do not trade actual currencies like the spot market. They deal in contracts that are representative of a currency type. The contract specifies a specific price for the currency at the date of settlement.
The forwards market deal with contracts that are traded OTC by two parties who determine the terms of the contract between themselves.
In the Futures market, contracts are traded based upon a certain size and date on the commodities market. The contracts in this market have details that specify the units being traded and the dates of settlement.
The contracts in either of these markets are biding. However, contracts can be sold and bought before their expiry date. These markets offer risk protection when trading in the foreign exchange market. Big companies that want to hedge against fluctuations are the ones that use these markets. However, speculators also participate in these markets.