Lesson: Foreign exchange

Trading in the Foreign Exchange Market

The Forex market is open 24 hours a day, five days a week around the globe. 
Historically, foreign exchange market participation was for governments, large companies, and hedge funds. In today's world, trading currencies is as easy as a click of a mouse and accessibility is not an issue. Many investment companies allow individuals to open accounts and trade currencies through their platforms.
This is not like a trip to a foreign exchange kiosk. The process is entirely electronic with no physical exchange of money from one hand to another.
Rather, traders are taking a position in a specific currency in the hope that there will be some upward movement and strength in the currency that they're buying (or weakness if they're selling) so that they can make a profit. 

Forex Market vs. Other Markets

There are some fundamental differences between foreign exchange and other markets.
First of all, there are fewer rules, which means investors aren't held to strict standards or regulations like those in the stock, futures, and options markets. There are no clearing houses and no central bodies that oversee the forex market.
Second, since trades don't take place on a traditional exchange, there are fewer fees or commissions like those on other markets.
Next, there's no cutoff as to when you can and cannot trade. Because the market is open 24 hours a day, you can trade at any time.
Finally, because it's such a liquid market, you can get in and out whenever you want and you can buy as much currency as you can afford.

Types of Forex Transactions

Forex traders transact in one of three distinct marketplaces: the spot, the forward, or the futures market.

The Forex Spot Market

The spot market is the most straightforward of the Forex markets. The spot rate is the current exchange rate. A transaction in the spot market is an agreement to trade one currency for another currency at the prevailing spot rate.
Spot transactions for most currencies are finalized in two business days. The major exception is the U.S. dollar versus the Canadian dollar, which settles on the next business day.
The price is established on the trade date, but money is exchanged on the value date.

Role of the U.S. Dollar

The U.S. dollar is the most actively traded currency.3 The most common pairs are the USD versus the euro, Japanese yen, British pound, and Australian dollar.4
Trading pairs that do not include the dollar are referred to as crosses. The most common crosses are the euro versus the pound and the euro versus the yen.
The spot market can be very volatile. Movement in the short term is dominated by technical trading, which bases trading decisions on a currency's direction and speed of movement. Longer-term changes in a currency's value are driven by fundamental factors such as a nation's interest rates and economic growth.

The Forex Forward Market

A forward trade is any trade that settles further in the future than a spot transaction. The forward price is a combination of the spot rate plus or minus forward points that represent the interest rate differential between the two currencies.
Most forward trades have a maturity of less than a year in the future but a longer term is possible. As in the spot market, the price is set on the transaction date but money is exchanged on the maturity date.
A forward contract is tailor-made to the requirements of the counterparties. They can be for any amount and settle on any date that is not a weekend or holiday in one of the countries.

Forex Futures

Unlike the rest of the foreign exchange market, forex futures are traded on an established exchange, primarily the Chicago Mercantile Exchange.
Forex futures are derivative contracts in which a buyer and a seller agree to a transaction at a set date and price.
This type of transaction is often used by companies that do much of their business abroad and therefore want to hedge against a severe hit from currency fluctuations. It also is subject to speculative trading.