The need to exchange currencies is the primary reason why the for-ex capital market is the largest, most liquid financial market in the world, with an average traded value of around U.S. $2,000 billion per day. There are actually three ways that institutions, corporations and individuals trade for-ex capital market: the spot market, the forwards market and the futures market.
Activity in for-ex capital market
The for-ex activity in the spot market was not always the largest market because it is the “underlying” real asset that the forwards and futures markets are based on. In the past, the futures market was the most popular game for traders because it was always available to individual investors for a longer period of time. But with appearance of automated trading in for-ex capital market, the spot market has witnessed a huge spike in activity and now by far ahead of the futures market as the preferred trading market for individual investors. These data, when people refer to the for-ex market, they usually mean the spot market. The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.
Characteristics of the spot market
More specifically, the spot market is where currencies are bought and sold based on current price. That price is result of supply and demand. Current price is determent by many things like existing interest rates, economic performance, reflection from ongoing political situations (both locally and internationally), as well as the prediction of the future performance this currency against another. Finalized deal is known as a “spot deal”. It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, sides exchange cash. Although the spot market is commonly known as one that deals with transactions in the present, it usually tales two business days for deal to be executed. Spot market trading is the most dynamic part of for-ex capital market.
What are the forwards and futures markets?
There is one major difference in trading in forwards and futures markets. Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead deal is closed in contracts, that gives them right to a certain currency type, a agreed price per unit and a future date for settlement.
In the forwards market, contracts are bought and sold over the counter. In these contracts parties specify the terms of the agreement execution.
In the futures market, more stable part of for-ex capital market, contracts are traded based upon a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In the U.S. body that regulates the futures market is the National Futures Association. Specific details like the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized have to be stated in these contracts