When you hear about Forex, you probably think about the spot Forex trading, usually online. But the foreign exchange market consists of several types of transactions that affect the currency rates and not all of them are part of the spot trading process. These popular Forex trading types include:
- Spot Forex — the usual way to trade Forex. Spot currency trading does not involve physical delivery of currencies and is performed between two parties, using over-the-counter (OTC) electronic methods. It has the second biggest share in the daily FX turnover, following foreign exchange swaps (which are not tradable in the retail market). Most of retail Forex traders are doing this type of trading.
- Binary options — even though it was one of the simplest ways to participate in currency trading, it is now illegal for brokers to offer almost anywhere in the world. When you are trading binary options, you either win a predetermined amount of money if the currency pair is above or below the given target (called strike price) at some particular moment or you lose a predetermined amount of money if the currency pair fails to reach the price objective. Of course, there are other types of binary options available, but they all are characterized by the fixed risk/win amounts. This financial instrument gained its popularity partly due to qualifying as a nontaxable source of income in some countries.
- Options — or vanilla options — are the special derivative contracts where two parties agree on a transaction at a reference price (strike price). Vanilla options have a more confusing valuation model compared to binary options. Currency options market can be OTC (like the spot market) and exchange-based. Due to its complexity, it is not very appealing to an average FX trader.
- Futures — the way currencies and currency indexes are normally traded on exchanges (for example, on the ICE). Futures traders buy a delivery of currency on some particular date at a price determined today. Unlike spot Forex, futures trading is mostly regulated and remains popular even with the advent of the mass spot trading.
- ETFs — an ETF stands for an Exchange-Traded Fund, which can hold a currency or a basket of currencies, allowing traders to invest in those assets by buying the ETF via an exchange at a rather low cost. It is a handy tool to trade baskets of interconnected currencies for hedging purposes. ETFs also provide additional liquidity to the markets. Once very popular, currently there are only about 18 widely traded currency ETFs available in the United States.
- Physical currency — while many people participate in currency exchange when traveling abroad or buying imported goods, it is also possible to trade physical currency speculatively, buying and selling particular currencies according to your expectations. It was a popular method of investment in various emerging countries' currencies in 2000's and still remains popular in some third-world countries.
With binary options falling from the regulators' grace, vanilla options being too complex, and FX futures barely accessible to small traders, most retail participants will likely continue to trade the traditional spot FX offered by online brokers for a long time.
If you know some other, more creative, ways to participate in the global foreign exchange market, please feel free to join our Forex forum for a discussion.
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