Understanding Dow Futures – Part 7

What is Forex Market?

The forex market or Foreign Exchange (Forex) is a relatively new phenomenon. While we can trace futures and stock trading back over 100 years, forex trading history began just 30 years ago. What makes this market tremendously interesting is that it went from nothing to being the largest volume-traded industry in the world, with over US$1.5 trillion traded daily.

While the majority of forex traders know only about the spot forex side, forex began in the futures market. It has a robust spot, futures, and options trading environment. Each market interacts with each other and there are few, if any, real boundaries that affect how they react to the same supply and demand numbers.

What makes it unique is that the spot market for forex allows “speculators” to get involved with little to no investment. This is a function of the over-the-counter market which has changed the rules of what is required of investors and the proliferation of high speed internet connections that allow anyone to bring currency dealers right into their homes. How did this happen? Was it by design? Or was it by accident?

What Is the Spot Market?

Forex trading falls into three arenas: spot, futures, and options. The majority of new forex traders learn only about spot forex trading. While the spot market has some advantages, don’t ignore the futures and options forex markets.

This schism between spot, futures, and option forex developed early on. Banks developed control of the spot forex market in what is known as the over-the-counter (OTC) market. They initially offered spot forex services as a way to provide added value services to their large multinational clients. In the beginning these spot transactions were considered essential for multinational corporations to operate quickly.

The banks also considered OTC forex to be a risk-free way of generating profits. Banks consider the spread between currency bids and ask as free money. Banks have always fought to make sure that foreign currency exchange was seen as an express power of banking, with no need for additional regulatory oversight. With such an aggressive stance by the banks, the OTC market’s explosive growth was inevitable.

While much of foreign exchange trading could have been conducted on the regulated exchanges, the banks didn’t support it and created their own instruments as substitutes. OTC forex has expanded from its early roots as a spot transaction market for just multinational corporations to include retail investors. Over US$1.5 trillion is traded daily. The majority of this growth has been fueled by independent dealers, which now outnumber banks in offering OTC currencies.

Discussion on Understanding Dow Futures – Part 7