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Sunday, October 25, 2009

Spot Forex Market (Part I)

By Ahmad Hassam

The spot forex market is an over the counter market. The spot forex market is a decentralized network of buyers and sellers. There is no physical central exchange that acts as a central clearing house.

Stocks, options and futures all are traded on centralized exchanges with a clearing house as the intermediary. This brings a lot of order in these markets. Unlike the forex futures trading that is carried out through the exchange like CBOT, CME etc, over the counter in spot forex means that the buyers and sellers make a binding contract with each other after agreeing on the price and this is not carried through an exchange. The buyer and sellers can agree on any price!

What are the advantages of a centralized market over OTC market? There is a better price discovery in a centralized market and there is trading anonymity something that big players want to hide their trails. There are several other advantages of a central exchange too like the counterparty risk for the trade is reduced. Forex traders in the spot forex market carry out their activities by dialing directly with one another or through brokers on telephone or internet.

In 2007, Chicago Mercantile Exchange (CME) along with Reuters launched FXMarketSpace; the worlds first centrally cleared global forex market place. In this centrally cleared system, CME will act as the clearing house and guarantee the performance of all the contracts for both buyers and sellers.

Only sophisticated investors with net worth of more than $20 Million can trade on the FXMarketSpace. Unfortunately FXMarketSpace is an institutional trading platform and is not open to retail forex traders.

There are many players involved in the spot forex market. The spot forex market has long been the playground of only the biggest and the baddest global banks. At its core, the spot forex market is a credit market. The dominance of big banks is unlikely to be challenged soon. Recently NFA (National Futures Association) had also passed certain new rules that make it more skewed against the small investor like you and me. The spot forex market is still skewed against the retail forex trader. Why is it so?

With the advent of the internet, it became possible to introduce trading platforms for the retail investors. Previously spot forex trading was the playfield of the big banks, multinationals and the hedge funds.

The forex market differs from other traditional financial markets. Things deemed illegal in most of the other financial markets are simply considered part of the game in the forex market. Insider trading, front running, price shading etc are all regularly seen in forex trading and have no legal repercussions whatsoever. Retail spot forex is seeing a lot of growth in the recent years. A mushroom growth of online forex brokers took place. Many did not have even enough capital with them to start the brokerage business. Most of these forex brokers behave like bucket shops. But this is the way; the spot forex market has developed over the years.

It is essential for you that you understand the nature of the spot forex market and who are the main players. Why they trade forex? What type of advantages they have over the retail forex traders?

Over the counter (OTC) means that the spot forex market is spread all over the globe with no central location! Over the counter nature (OTC) of the spot forex market means that currency transactions do not take place at any single place. No government oversight and no central deal book to compare trades means that the banks can pretty much do whatever they want to their unsuspecting customers.

A players access to the spot forex market depends on the quantity of transactions of large amounts of money. Players in the spot forex market range from those who trade billions of dollars daily to those who only trade just a few thousand dollars daily. Now who are the main players in the forex market against whom you as a retail forex trader will be competing? - 23212

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