For newcomers to forex trading, the different choices available for forex trading can be a little bewildering. What is the most appropriate way of trading global currency markets for your personal circumstances? Below are some of the options available for anyone who wants to start taking advantage of movements in currency markets.
Financial spread betting
Only available to residents of the UK and the Republic of Ireland, financial spread betting allows you to trade forex markets using margin (money the broker lends to you to exploit price movements – fairly essential for FX markets as their relative movements are usually smaller). Spread bets are priced on a per point basis – i.e. the amount of points the price moves while your trade is open. Traders control their risk by staking amounts per point on the trade – e.g. £1 per point would be far less risky than £5 per point.
Contracts for difference
Outside the UK and Ireland (and also outside the USA), contracts for difference or CFDs have become one of the most popular means of trading forex markets. CFDs will be priced by your broker and like shares, a trader makes or loses money based on the change of the price in that CFDs. These are over-the-counter derivatives, a contract between you and your broker. You cannot move a CFD between brokers nor are they traded on an exchange. But like financial spread bets (above), they are traded using margin.
Margined foreign exchange
If you cannot open a spreading betting or CFD account, you may want to consider margined forex trading. This particularly applies to residents of the USA where CFDs are not permitted. Brokers will still lend traders most of the amount of the trade (usually at least 90%), but in this case the trader is buying and selling actual currency, rather than a contract priced by the broker. Larger minimum trade sizes will frequently apply. Margined forex contracts will tend of have a fixed lifespan, so you will need to be sure you will be out of the trade before the time horzon expires.
Spot foreign exchange
For larger investors, like very wealthy private individuals or fund managers, spot foreign exchange trading offers the ability to trade currency without margin. However, if you do not want to use a trade that involves your base currency, you will have to acquire at least one of those currencies for yourself. For example, an Australian trader might need to acquire GBP to make a GBP / EUR trade. Brokers can offer traders of spot FX swap facilities – agreeing to swap one currency for another at a set rate for a limited time period.
Exchange-traded futures based on specific currency pairs are also available for those who want to trade the future price action of forex. Currency futures have the advantage of narrower spreads and the scope to be sold to other parties. On the downside, minimum trade sizes are larger – typically at least US$ 25,000 – and the futures can only be sold when the exchange they are listed on is open.
Options contracts allow you to buy or sell forex pairs at a particular price. Traders of European style options (which tends to be the type that most forex option contracts conform to) will have either a put (sell) or call (buy) option for that currency at a future date agreed with the broker. You don’t need to exercise the option when the date arrives, but those who forecast the market correctly have the opportunity to trade at an advantageous price. Options can themselves be traded, and in addition, some brokers allow traders to spread bet on the price of options, rather than buying options themselves. This can be a lot cheaper for the smaller investor.
Most Exchange Traded Funds (ETFs) are cheap, index tracking funds that seek to track the performance of a stock market index. They can be bought and sold via stock brokers like shares can. A currency ETF follows the price of a particular currency pair instead, allowing share traders to easily buy or sell funds based on currency prices. Leveraged versions are also available, but currency ETFs are more suited to investors taking medium to long term views on currency prices rather than short term, week to week price action.