Since the world of foreign exchange is so vast, there are various amounts of instruments used for forex trading. These instruments are used in different forex markets worldwide and have their characteristics and properties according to which they can be traded.
Nature also varies from instrument to instrument, and every forex trader has their own choice. They usually trade mostly on any one specific type of instrument in which they have the most expertise.
However, we recommend that you learn all the basic instruments used for forex trading and give all of them a try to get a fully-fledged taste of currency trading.
Here in this article, we have explained the 4 common instruments used for forex trading that will help you a long way as a forex trader.
As evident by the name, this instrument is used for future trading. It is a contract or an agreement between the buyer and the seller regarding the exchange of a certain asset at a predetermined price on a specific date in the future.
Currency futures are always quoted in terms of currency value with respect to the USD.
Futures are standardized and are traded in centralized exchanges which make the process of these trades transparent and well-regulated hence minimizing the risk. They are generally carried out within three months.
A currency option is similar to a futures contract where there are two parties involved to exchange currency at a specified date in the future. But this is where the similarity ends.
In a futures contract both the parties are obliged to follow the instructions as agreed in the contract and deliver the asset. But in an option, only the writer of the option is obliged to buy or sell the asset at a specified price on the date of expiration.
The buyer of the option is not obliged to exercise the option if they do not find the price attractive on the expiration date.
The price at which the option become exercisable is called the strike price denoted by X, and a premium is paid by the option holder to the writer for the option in order to avoid unfavorable changes in the market. It is usually denoted by c and p for the call option and put option respectively.
Spot Forex Market
In this kind of market, currencies are exchanged on the spot in the Over-the-Counter (OTC) interbank markets. It is an agreement to buy or sell a currency at the current market price based on the currency exchange rates.
These types of agreements are usually settled on T+2 days which means within two business days after the day it is traded and is exchanged for cash. These two days provides the 2 parties involved in the transaction to verify and check the agreement details and coordinate with the clearinghouses for the settlement of cash accounts.
ETFs, the acronym for Exchange-traded funds, are fairly new in the world of forex. Currency ETFs are usually created by financial institutions that hold these instruments in the form of funds.
The shares of these funds are then offered to the public on an exchange which they can further trade on. It basically provides exposure to one currency or a bunch of currencies.