Forward, Future & Spot Markets in Forex
When trading foreign exchange , there are three main types of market from which to choose: spot, forward, and futures. Please note you cannot trade futures or options with Tradu; their inclusion here is for informational purposes only. In this guide, learn the differences between the three so that you can make better informed forex trades.
What is the forex spot market?
The forex spot market is an over-the-counter (OTC) market in which forex pairs are traded immediately in real time - on the spot. The spot market is one of the largest and most liquid markets, meaning that spreads (the commission charged by brokers) are smaller than futures and forward markets.
When trading on the spot forex market, you are using cash or margin to buy a currency (the base currency) and sell another (the quote currency). The position that you choose to open - whether the currency pair rises or lowers in price - has no set end date, so you can close your trade and either take profit or prevent further losses at any time. Typically, you won't ever own the currency - especially if you trade CFDs.
Trading prices on the spot market are driven by a range of supply and demand factors. This includes current and future economic performance, political developments, and interest rates in the countries in which the currencies are based. Learn what drives forex prices .
When you choose to close a spot position, you agree to a spot deal - the amount of currency that each party receives, based on the exchange rate between the currency pair. Once you close, this position is transferred into cash.
Cash isn't instantly delivered from the buyer to seller in the spot market. Instead, the two parties agree to trade using the price at that moment, but with the money sent one to three days later, the duration shown by the T value (T+1, T+2, T+3 and so forth).
The advantages and disadvantages of spot forex market trading
Advantages
- Transparency: All prices and transactions are publicly available.
- Availability: Spot markets are popular and liquid, with tight spreads.
- Flexibility: You can close your position at any time, taking profits or curtailing losses, or choose to keep it open.
- Information: Spot prices don't expire, which means that there is a much longer horizon of price data available to analyse than futures and forward trading
Disadvantages
- Swap charges: Spot market CFDs left open overnight are affected by the Swap charge - a fee for keeping open a position overnight.
- Risk of loss: There is a chance that investors may open a position when the price is inflated, increasing risk of loss.
- Risk of default: Trades may be at risk of one party becoming insolvent and being unable to pay the other party when the position is closed.
What is the forex forward market?
Trading forex on the forward market involves speculating on the future price movements of a currency pair. It sees two parties enter into a contract (the forward contract) to buy and sell an agreed amount of a currency pair at a fixed price, settled on an agreed date.
The market is OTC, which allows parties to tailor their contract terms to a greater extent than futures contracts. Contracts are exchanged for cash and can be traded prior to the contract expiry date using an option date, too.
Forward forex contracts are used either to speculate on the future price movements of a currency pair or as a hedge against the risk of other investments in the trader's portfolio. Activity is helped by the fact that the forward forex market is highly liquid. Both forms of trading allow each party to ride out future fluctuations in the price of currency pairs.
Trading forex on the forward market works in a similar way to the spot market. You open a position on whether you think the price of the base currency will increase or decrease over a set time, enter into a contract with a buyer or seller, then either close your position early to take profits or minimise losses, or let the position mature on the agreed settlement date.
The advantages and disadvantages of forex forward markets
Advantages
- Certainty: Forward contracts, being fixed at a specific price, provide certainty which can be helpful when hedging against potential market risks.
- Flexible terms: Due to being OTC, terms are flexible between parties.
- Simplicity: Due to their set terms, forward markets are arguably simpler to administer than spot trading.
Disadvantages
- Availability: There are typically fewer currency pairs represented by forward contracts than by spots.
- Risk: Future events may occur which eat into or eliminate your profit.
What is the forex futures market?
The forex futures market is very similar to the forward market, except with a few key differences:
- They are traded on an exchange, like the London Stock Exchange.
- Futures contracts are traded based on standard order sizes, settlement dates and other terms, set out by the exchange on which they're traded.
- Futures contracts are traded 'marked to market' each day, which means that they are settled at the end of each daily trading period, not just when the contract reaches its stated maturity.
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