As mentioned in previous lessons, Forex is the market where you trade with currencies. In Forex, the financial instruments used to invest are:
- The spot;
- The Future;
- The Options;
- The ETFs (Exchange-Trade Funds).
Trading in the SPOT Market
The SPOT Forex market is that where there are the traders who are also Signal Providers in Social Trading.
Therefore, it’s the market that, from an operational standpoint, we are most interested in, in order to better understand how it works and then be a more conscious investor.
Characteristics of the spot market
The Forex Spot Market is OTC (Over the counter). As we have already seen, OTC indicates that it has not a specific trading venue. The liquidity, the correctness and the security of the transactions are guaranteed by each party engaged in the trade, including all major international banking groups.
As there is no headquarter, there are no official prices of the market, but the trading exchanges are communicated by all the major players in the international telematic networks such as Reuters and Bloomberg, that spread them instantly and globally.
It’s a “spot” market, i.e. a market where the trading price is fixed instantly by the two parties and the exchange of the treated products is regulated at the end of the same execution day. However, with the mechanism of “rollover” you can postpone indefinitely the date of closing of the transaction, in front of a payment of a small interest called “swap”, which can be paid or received (If the interest rate of the currency you buy is greater than the interest rate of the currency you sold, then you will have a gain of swap, or vice versa a loss of swap).
The spot market is by far the most liquid, flexible and accessible among all the markets we are going to analyze, where brokers give to their users most of the services for free.
Forex spot: the world’s most popular currencies market. Why is that?
Let us briefly analyze some of the reasons that led Forex Spot to be the most liquid market in the world and the most widely used by banks, large investment funds, small traders, in addition to being the market in which Social Trading is developed.
It’s a market open 24 hours and this makes the charts very smooth and linear, given the absence of gaps (in the markets closing in the afternoon and reopening in the morning we often find “holes” in the prices quotation among the closing price and the reopening price), a very positive thing for those who work using technical analysis. For this reason, the analysis are much easier and profitable. Small gap may arise, however, over the weekend, that is the only moment in which Forex is closed.
Being the most liquid market in the world also means never having problems running a particular order. In other words, if we want to buy there will always be someone willing to sell, and vice versa. We will never find ourselves in the position of not being able to close a transaction for the absence of a counterpart.
These two characteristics alone, the 24 hours opening and the immense liquidity, give the opportunity for programmers to design automated trading systems, more or less professional, which can operate in automatic mode, 24 hours a day, relying on the fact that the market has always a price for those who want to buy, and one for those who want to sell.
As we have seen in previous lessons, the user has the ability to operate by margin, being able to exploit even very large margin, together with the freedom to operate with leverage, ranging from nano lots (newly invented, for the less capacious pockets) to micro and mini lots, getting also to the most professional and known standard lots.
In this market brokers usually do not take commissions, but their earnings are based mainly on the payment of the spread by the users, for each transaction open.
The operations can be handled with a MT4 trading platform (the most common for trading on the forex spot and the one that made possible the evolution and the rise of forex autotrading), very stable and light and that, at no cost, gives the possibility to operate on the market with real or demo money. All of these accessibility characteristics have made Forex Spot one of the favorite markets among retail investors.
Trading on the FUTURE market
The futures market, on the contrary of the spot, is a regulated market.
The future, as the name itself said, is an future trading instrument, and is also derivate (its price is based on an underlying). It’s a contract by which a person is committed to buy or sell at a specified future date, a specified underlying asset at a specified price.
In the case of Forex, we talk of financial futures, which as underlying have currencies themselves.
These contracts have quarterly deadlines (March, June, September, December). The value of a futures contract is Euro 125,000.00 and the minimum variation is 0.0001 tick, then € 12.50 per tick.
Trading with OPTIONS
Options are trading instruments that in Forex are fairly recent. They are listed on regulated markets, and the contract characteristics are standardized.
They give to the purchaser, upon payment of a premium, the right, but not the obligation, to buy (call) or sell (put) a specified quantity of the underlying asset at a specified price at a specified future date. The seller of an option instead sells the right described above.
The disadvantages of this instrument, compared to the usual and famous Spot activity, are determined by the much more limited trading hours and the lack of liquidity.
But there is an advantage that offsets the previous disadvantages, that is the flexibility given by the possibility to build strategies, even very complex, which give way to earn even in markets that maintain lateral price range. Options are definitely the latest tools that are used for the operation on currencies.
Trading with ETF
ETF stands for Exchanged Traded Fund.
ETFs are, for the most part, passively managed funds, or funds that replicate the performance of an underlying.
These instruments are primarily used for a rapid creation of diversified investment portfolio, being this funds also built on different underlying gathered in one fund, or, as in the case of Forex, to allow investors to hedge and reduce the risk of their operations in other markets by investing easily on Forex market.