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Forex Trading Instruments

There are different ways that forex can be traded:

Spot Transaction: This constitutes the most common method of trading forex and the highest transaction share in volume. This type of transaction is a direct exchange of two currencies in the shortest time frame. It excludes any interest and involves cash rather than a contract. Spot transaction typically call for two-day settlement.

Forward Transaction: In this type of transaction a specified quantity of a currency is purchased or sold at a currently established exchange rate with payment and delivery at a specified future settlement date. Actual money is not exchanged until the agreed upon future date. The settlement date can be days, months or even years.

Forex Swap: This is one type of forward transaction where the two sides exchange currencies for a specific time period and agree to reverse the transaction at a later date, hence the name "swap". These are traded over the counter and may not be standardized.

Currency Future: Forward transactions with standard contract sizes and maturity dates. A certain amount of currency is agreed upon to be sold or bought at a specific price on a certain maturity date. The buyer and seller are obligated to fulfill the trade on the settlement date unless the contract is sold to another before that date. Forex futures are exchange traded, typically with quarterly settlements.

Forex Option: Commonly known as FX options, a type of derivative where the owner retains the right but is not obligated to exchange a specific amount of currency for another at an agreed upon exchange rate on a specified future settlement date. The forex options market is the biggest and most liquid options market worldwide.

ETF (Exchange-Traded Fund): These are open-ended funds traded on stock exchanges. ETFs were initially created to replicate a stock market index such as the S&P 500 or Dow Jones Industrial Average and became popular due to their tax efficiency and stock-like liquidity features. Now there are ETFS that replicate currency market investments; for example they increase in value when the US Dollar goes down in value versus some other currency such as the Euro.

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