Foreign Exchange Trading

The foreign exchange (FX) market is a huge global market that operates 24 hours a day, except for weekends, trading in different currencies and it is this FX trading that determines the exchange rates at which we can be foreign currency.

Banks around the world use specialist firms known as dealers, who paradoxically are also usually banks, who trade in huge volumes of volume exchange which can involve hundreds of millions of dollars at a time.

The end result of all this FX trading is that the man in the street and companies around the world can buy and sell goods and services in different currencies as well.

According the Bank for International Settlements the average daily trading in foreign exchange in 2013 is in the region of $5 trillion per day. FX trading consists of two man types; Spot trading, which is where one currency is sold for another currency at an agreed rate there and the then and a number of derivatives such as currency options, currency swaps, currency options and forward contracts.

Spot Transaction

Spot transactions account for around 40% of all FX trading and are agreements between two parties to sell one currency for another on the spot date at an agreed exchange rate.

Forward Transaction

A forward currency exchange transaction is an FX trade where the buyer and seller agree to sell one currency for another at a date in the future but at an exchange rate agreed today.

This is where the terms long and short trading come from. The party agreeing to buy the currency in the future is taking the long position and the party agreeing to sell the currency in the future is taking the short position.

Swap Transaction

A currency swap is a form of FX trading whereby an agreement is made to simultaneously buy and sell identical amounts of currency on different dates and is typically used as a hedge against future future exchange rate rate fluctuations.

The two transactions are normally conducted, one at the spot rate and the other at the future rate and it allows companies to minimise their currency exchange risk by maintaining equilibrium of currency values on their balance sheets. The dates between the two transactions are normally only a matter of days.

Currency Option

A currency option is an FX trade whereby an agreement is reached that gives the owner of the trade the right to buy currency in the future at a previously agreed exchange rate but not an obligation to.

With its huge trading volume, wide geographical dispersion and its near continuous operation, the FX trading market is considered to unique and often cited as being the nearest that there is to a perfect market.