Forex Market Overview

Among the most rewarding of the markets opening up to traders is the Foreign Exchange market. Identifiable trading patterns, as well as comparatively low margin requirements, have rewarding trading opportunities for many.

In contrast to the world’s stock markets, foreign exchange is traded without the constraints of a central physical exchange. Transactions are instead conducted via telephone or online. With this transaction structure as its foundation, the Foreign Exchange Market has become by far the largest marketplace in the world.  Average volume in foreign exchange exceeds $1.5 trillion per day versus only $25 billion per day traded on the New York Stock Exchange. This high volume is advantageous from a trading standpoint because transactions can be executed quickly and with low transaction costs (i.e., a small bid/ask spread).

As a result, foreign exchange trading has long been recognized as a superior investment opportunity by major banks, multinational corporations and other institutions. Today, this market is more widely available to the individual trader than ever before.

Spot foreign exchange is always traded as one currency in relation to another. So a trader who believes that the dollar will rise in relation to the Euro, would sell EURUSD. That is, sell Euros and buy US dollars. 

Spot Forex versus Currency Futures

Many traders have made the switch from currency futures to spot foreign exchange ("forex") trading. Spot foreign exchange offers better liquidity and generally a lower cost of trading than currency futures.  Banks and brokers in spot foreign exchange can quote markets 24 hours a day.  Furthermore, the spot foreign exchange market is not burdened by exchange and NFA ("National Futures Association") fees, which are generally passed on to the customer in the form of higher commissions.  For these reasons, virtually all professional traders and institutions conduct most of their foreign exchange dealing in the spot forex market, not in currency futures.

The mechanics of trading spot forex are similar to those of currency futures.  The most important initial difference is the way in which currency pairs are quoted.  Currency futures are always quoted as the currency versus the US dollar. In Spot forex, some currencies are quoted this way, while others are quoted as the US dollar versus the currency. For example, in spot forex, EURUSD is quoted the same way as Euro futures.  In other words, if the Euro is strengthening, EURUSD will rise just as Euro futures will rise. 

On the other hand, USDCHF is quoted as US dollars with respect to Swiss Francs, the opposite of Swiss Franc futures. So if the Swiss Franc strengthens with respect to the US dollar, USDCHF will fall, while Swiss Franc futures will rise.  The rule in spot forex is that the first currency shown is the currency that is being quoted in terms of direction.  For example, "EUR" in EURUSD and "USD" in USDCHF is the currency that is being quoted.

The table below illustrates which spot currencies move parallel to the futures contract and which move inversely (opposite):