The Forex market is being widely used for the multiple applications.
The Forex market is used to generate the pure profits by some participants like the hedge funds etc., from the fluctuating exchange prices. The other participants like commercial companies use the service for foreign exchange to convert currency for cross country business transactions.
There prevails the different kind of applications in the market for currency trading facilities, this is the reason that the market is being split up into different types of Forex markets and sub markets. Let’s have the quick look at the major 1 sub markets of Forex market.
The Forex Spot Market
Out of all the sub markets, the spot market is the largest market among all and it is the right place for trading as the retail Forex trader. Currency here is bought and sold for the instant delivery or for at least in the very near future date. The word ‘spot’ came from the ‘on the spot’ type trading.
Let’s take the real life example…
A person went to currency booth at the airport to cash his USD dollars for the Japanese Yen. He handed over the cashier his USD currency and the cashier immediately gave him back the equivalent Yen.
This was ‘on the spot’ currency transaction with the cashier at the currency booth and this is the simple analogy of the basic way of working of the operation of Forex market. Traders tend to exchange their currencies ‘on the spot’, with instantaneous transactions.
Spot market is the place where you will find most of the retail traders and this market makes about 40% of the total trading activity.
The Future Market
Future market deals with the trading to be done at some future date at a specified time based on the contacts. Commodity or currency is scheduled for delivery at the specified future date on the contract basis at the predetermined price.
As the future market is centralised, so all the contracts are opened with the central exchange. The future market is traded by the retail traders and by hedge funds for the profit making purpose, so it is more utilized for commercial purposes.
Example 1: A farmer might enter in a contract to sell his wheat to a person in future on a decided date. So with this contract, the farmer has a guaranteed buyer for his crop which will grow in next three months. The crop will be sold on a predetermined price.
Both the parties i.e., the farmer and the buyer has to agree on the same contract about the selling of the crop on the predetermined date and predetermined price.
This is the main advantage to the farmers because he doesn’t have to worry about his crop for the reason of ‘stock going bad’ because of the contract buyer. His fresh grown crops don’t go waste.
Example 2: Apple company is planning to launch its new iPhone in the market, the next big thing to hit the market.
In order to manufacture enough products in the market at the time of launch, Apple needs to assemble and order some of its parts from some Japanese manufactures, which takes specified 4 months to produce the goods which are required by them.
Apple will need to convert its USD dollars to Japanese Yen in order to pay to the manufactures. So instead of waiting for the 4 months and paying the exchange rate for USDJYP at the time of completion date, Apple buys a JPY future contract which is set to expire in 4 months.
In this way Apple can easily lock in a contracted future price for the JPY instead of running the risk of the Japanese Yen which can increase over the 4 months manufacturing period, which can really turn out to be an expensive transaction.
This thing is known as hedging and the commercial companies usually does this thing all the time to protect themselves from changing currency rates which have the possibility of changing against them.
The Forward Market
The forward market is the last type of the Forex market.
Forward market is also similar to the Future market in most of the aspects as the forward market is another contract based transaction.
We have already discussed about how the future contracts are being settled through an exchange, where the Forward market is decentralised. The contracts details are directly set between the two parties involved.
The contract agreement provides with a lot of flexibilities in the terms of settling the price and also regarding the contract expiration date.
Forward contracts continue till either of one party closes the contract due to which the forward contracts even continue for past of their expiration date.
The uses of the forward market are very similar to the Future contract except for some uses like the forward contracts can be more customised or tailored to the customer’s requirement.
So all these markets i.e., the spot market, future market, forward contract market make up the majority of the Foreign Exchange market.
Future and the Forward contracts are usually taken up by the big companies which have a lot of money with them and the retail traders only need to worry about the spot market.
Out of all the different types of Forex markets, the spot market wins with it’s simplicity, straightforwardness and easy implementation. This is how Forex trading should be.