Foreign currency exchange.
The foreign currency exchange is a global over-the-Counter market for the international trading of various currencies. This market involves all aspects of purchasing, trading and exchanging different currencies in current or predicted prices. This market is highly liquid, since any investor can gain and lose on the trades within a matter of minutes. It also has high transaction cost. With millions of dollars every day changing hands, it is considered as one of the most liquid financial markets in the world.
Trading is done through brokers who buy and sell the currencies with the help of individuals, banks or other institutions. The brokers decide on the best deals after analyzing the movements of the foreign currency exchange market. This is known as Forex speculation. Individuals, banks and other financial institutions participate in Foreign currency exchange. These individual investors make money when the exchange rate goes up.
Forex speculation refers to the buying and selling of Forex currency pairs on the Forex exchange. Foreign currency exchange is traded through four types of transactions namely: direct, spot, futures and centralized clearing. Spot exchange, as the name suggests, deals with the exchange of currency through a broker directly. On the other hand, centralized clearing involves clearing and settling transactions made by clearinghouses over the counter. The process is usually supervised by regulatory bodies like Commodity Futures Trading Commission (CFTC) and National Futures Association (NFAA).
Forex speculation involves speculating on the movement of a particular currency pair. The speculation is done based on the changes in the exchange rate between two countries. If the exchange rate goes up, then the individual investors take a profit. If the exchange rate goes down, the individual investors will have to face a loss. There is also an opportunity for the investor to gain profit if the other country's currency drops in value.
In Forex trading, the most significant element is the bid-ask spread. The bid-ask spread is the difference between the price of one currency and the price of the other. This is determined by the market makers (also known as Forex market makers) who influence the foreign currency exchange rates. The CFTC or Commodity Futures Trading Commission manages the Forex market and the trades on behalf of the investors. The agency also issues statements regularly informing the traders and investors about the changing foreign currency exchange rates.
On the other hand, Spot market makes use of an auction system, which is a short-term trading program where the traders make bids to buy and sell the foreign currencies. The CFTC permits the four main currency trading operators to participate in the auction trading system and determine the opening and closing prices of the foreign currency exchange. This is in contrast to the spot market where the Forex dealers may buy or sell currency immediately after the market opening. Spot market on the other hand is the place where the trade is done not through bidding but the supply and demand of the currencies in relation to each other. The other difference between the two markets is the lack of a physical exchange location.
Spot foreign currency exchange rate takes longer time to determine and is based more on supply and demand in relation to the valuations of the currency in another country. Hence, it takes a bit longer time for this rate to be determined. Forex transaction takes place across geographical and time boundaries. For instance, the trade in commodities is handled through various locations such as ports, airports, railway stations, and highway stations whereas forex transactions are usually handled through the internet and by telephone or through fax.
Foreign currency trading involves high transaction costs, which are usually passed on to the customers. In order to reduce the transaction costs, the best thing to do is to carry out forex transactions when the rates are low and the currency valuations are good. There are many instances when such conditions are not present, which may result in the purchase or sale of the currencies off-exchange. These circumstances occur when there is uncertainty about the economic standing of the respective country and currency or the political stability of that government.