Traders may find better opportunities in various global markets, but the forex exchange market is complex and difficult to participate in. What Is the Forex Exchange Market? How the Forex Exchange Market Works? What Are the Types of Forex Market? these all are the things that are important for proper participation and developing strategies in the most effective way.
The forex (foreign exchange) is an international market for exchanging national currencies. The market works 24 hours a day and is the largest and most active financial market in the world, with daily trading volumes of more than $6 trillion. Interbank market activities are controlled by banks, financial institutions, and freelance operators.
This blog seeks to explain what the forex exchange market is and how it operates, as well as the basic principles underpinning currency trading, market participants, and trading sessions. We present the types of forex markets, spot markets, forward markets, futures markets, and options markets, with their characteristics. This way, you will be better positioned by gaining a basic understanding of sailing through the investment or trading venture within the forex market.
What is The Forex Exchange Market?
Forex, foreign exchange market or currency market is an over-the-counter, i.e. decentralized financial market where different currencies of the world are traded. But the major factors in it are GDP, inflation, how much debt is there on a country, that remains a big factor.
As Forex participants, one can see Retail Traders, Commercial Banks, Financial Institutions, Hedge Funds, and even the Central Banks of the countries. All the currencies in the Forex Market are always traded in pairs. For example, USD-INR. In this currency pair, USD is the base currency that you are buying and INR is the quote currency that is being sold.
In currency pairs, the value of one currency is based on the other, which establishes how much a country can purchase the currency of another country. And to build this price connection in the global market is the main goal of the Forex market.
But it completely depends on the governments as to how they have to define their currency value.i.e. whether they want to keep their currency free-float or fixed-float. Free-floating currencies are those whose value is determined through supply-demand dynamics.
On the other hand, the relative value of the currencies is decided by the governing body of a nation, they are called fixed-floating currencies. Like Indian Rupee, US Dollar, and the Japanese Yen are free-floating currencies.
On the other hand, Saudi “Riyal” and Panamanian “Balboa” come under the category of fixed floating currencies.
How the Forex Exchange Market Works?
As we discussed that the value of currencies are based on supply and demand. So, if the supply of a currency is more than the demand in the market, then its price will go down. And if the demand for the currency is more than the supply, then definitely the price of the currency will increase.
To handle this Forex trade on a national level, countries maintain a balance of payment or BOP account. When a country makes a payment in a foreign currency, that amount is debited from the BOP account. And when that country receives a payment in a foreign currency, it is entered into the credit side of the BOP account.
Overall, if the BOP account is in surplus, it means that the inflow of foreign currencies is more than their outflow, which eventually makes the currency of that country strong. But if the BOP is in negative, that is, in deficit, then the foreign currency demand in that country is more, which means that the national currency of that particular country is weak.
And similarly, through currency trading, the value of one country’s currency is always more or less than another country’s currency.
Types Of Forex Markets
If we talk about categorization, there are three types of Forex markets:
- Spot Market
- Forward Market
- Futures Market
Spot Market
The forex spot market is the current market for trading currency in which customers receive delivery right away for the amount paid or within, maximally, two business days.
About 30% of all forex trades are in the form of spot transactions, which amounts to the most common type of trade in the forex market. In the spot market, traders will buy and sell the currency pairs based on the current exchange rate, to gain from the difference in the forex market price. There is always high liquidity, few transaction costs, and very effective execution times in the spot market.
Forward Market
The forwards are the over-the-counter means of making a deal to trade in forex at a future date and under a predetermined exchange rate. They are customized agreements between two parties to buy or sell a stated amount of currency at a set rate and time in the future.
The forward contract is a unique one, unlike the spot. This is because it can be structured in a way that suits the two parties. The forward market is very relevant to corporate and investor entities for hedging against currency risk or even speculating on future exchange rates.
Futures Market
Forex futures market is an exchange-traded market trading in standard currency futures contracts. A currency futures contract, in the contract, entails an agreement to sell or buy a stipulated amount of currency at a predetermined price at a date in the future.
The contracts are exchange-traded and, in general, are traded on organized exchanges such as the Chicago Mercantile Exchange, where they are settled daily and require margining. Large institutions and speculators typically use the futures market to protect themselves against currency risk or to make profits in anticipated exchange rate movements. However, the futures market is generally less liquid than the spot, as well as it may include a higher transaction cost.