Did you know there are 180-different currencies used around the globe? The vastness of the forex markets provides traders with unlimited opportunities. The key to your success will be determining how well one currency will perform relative to another currency. When you trade the forex markets the financial instruments are referred to as currency pairs. They are valued using an exchange rate. The exchange rate measures how much of one currency (the counter currency) you need to purchase the base currency. Several different types of financial instruments can be used to trade the forex markets, some provide leverage and others do not. What also makes the forex market so attractive is that it is active around the clock.
When is the Best Time to Trade the Forex Market?
The forex market is the most active of the capital markets with ample liquidity available 24-hours a day, 6-days a week. The European time zone, during London trading hours, is the most liquid, but there is also strong liquidity during the morning hours in North American and evening hours in Asia. The European major currency pairs, which include the EUR/USD, GBP/USD and USD/CHF trade most actively during the European time zone. The Asian major currency pairs, the USD/JPY and the AUD/USD trade most actively during the Asian time zone. The USD/CAD is most active during North American trading hours.
What are the Different Types of Trading Instruments?
Several different trading instruments are used to initiate risk in the forex markets. These instruments allow you to take a risk that tracks the performance of either an individual currency pair, such as the EUR/USD or a currency basket. A basket is generally the performance of one currency versus a basket of currencies. The different instruments include:
- OTC Currency Contracts
- Futures Contracts
- Contracts for Differences
- Exchange-Traded Funds and Exchange Trade Notes
OTC Contracts
Many large banks and investment funds actively traded over the counter (OTC) currency contracts. These contracts are a bilateral agreement between parties. The size of each trade and the settlement instruction can differ from trade to trade.
Futures Contracts
Another form of forex instrument is futures contracts. A futures contract is the obligation to purchase or sell a currency at a specific date in the future. Each contract has a specific size and matures on a certain date. The most active futures are traded on the Chicago Mercantile Exchange. The Singapore Mercantile Exchange, as well as the Intercontinental Exchange, also provide investors access to currency futures contracts.
Contracts for Differences
One of the most popular currency trading instruments are contracts for differences. These are also contracts that can vary in size and maturity date. Many brokers provide micro, mini, and regular size trading accounts. A contract for difference is a financial instrument that tracks the movements of underlying financial assets such as a currency pair.
ETF and ETN
Lastly, there are exchange-traded funds (ETFs) as well as exchange-traded notes (ETNs), that track the movements of currencies. These stock-like financial products might hold currency futures or over the counter currency product to track the movements of currency pairs or currency baskets.
Leverage
One of the advantages of trading the currency markets is the leverage than some of the financial products provide. Leverage is a form of borrowed capital that is embedded in each contract. Leverage can significantly enhance your trading returns, but it is a double edge sword and can also generate substantial losses. OTC contracts, futures contracts and contracts for differences generally provide leverage. ETFs and ETN can vary. Your forex broker or bank can provide leverage for currency trading through a margin account. Before opening a margin account, your broker will ask you several questions related to your trading experience and knowledge of the forex markets. The leverage that is offered can be as high as 500 to 1. This means that for ever dollar you have in your account, your broker can lend you 500 to place a trade. The leverage that is used for forex trading will significantly impact your returns. Here is an example.
It is also important to understand that your broker will need to see that you have the capital in your account to incorporate any losses that you might incur. As soon as you begin to experience an unrealized loss your broker will take additional funds to hold against your losing position. If you do not have the money available or in the account, your broker will have the right to liquidate your position. Make sure you understand the benefits and risks of leverage before you begin to trade using a margin account.
The Bottom Line The currency markets are active and liquid around the clock, with nearly 5-trillion dollars of notional value traded each day. There are more than 180-different currencies, but most active are the currencies that are major currencies. The most liquid time zone is during the European hours, but Asian currencies are more active during the Asian time zone and North American currencies (excluding the US dollar) are most liquid during the North American time zone. There are several different instruments that you can use to take currency risk including over the counter products, futures contracts, CFDs and ETFs/ETNs. One of the most attractive attributes of currency trading instruments is leverage. Leverage allows you to enhance your trading returns. Some brokers will provide leverage as highs at 500-1. You need to be careful when using leverage and understand that it is a double edge sword that needs to be treated carefully to enjoy its benefits and avoid the risk of ruin.