Financial instruments are easily tradable capital packages with their own structure and characteristics. They don’t exist outside the financial market’s context, and have form diversities. Their diversity, in return, reflects the risk of diversity they also offer.

Currency traders have a lot of financial instruments to choose from. Proficiency in forex trading entails understanding of those financial instruments.

Here are the most commonly encountered financial instruments in forex.

Spot Transactions

Spot transactions are simple currency exchanges. These have the shortest time frame as they are two-day delivery transactions (not including US & Canadian Dollars, Euro, Turkish Lira and Russian Ruble – they settle the next business day); they involve cash rather than contracts, and transactions do not include interests.

Swap Transactions

Contracts like these are usually not regulated and not standardized. It’s in the agreement where the strength and the compliance of the contract lie. What happens is that parties agree to trade currencies, and then give a future date for its reversal as a condition. Most swap transactions require a deposit or a security fund.

Forward Contracts

In a forward transaction, the two parties agree on a particular exchange rate today but will be delivered in the future and will follow the exchange rate agreed upon previously regardless of that day’s market rates. The duration of the transaction can be as short as a day or as long as a year as long as agreed upon by the buyer and seller.

Futures Contracts

Futures contracts are forward contracts with a pre-determined maturity date, currency amount and interest amount. These contracts are standardized and traded on exchanges e.g. Chicago Mercantile Exchange (CME). Usually, the median timeframe for futures contracts are three to six months.

Foreign Exchange Option

Foreign exchange options, or FX options, are derivative contracts. An FX option gives the holder the right, but not an obligation to trade money denominated in one currency to another at an exchange rate previously agreed upon on a particular date. This financial instrument is the largest, deepest and the most liquid market. The fixed exchange rate is referred to as the strike price.

There are two option styles: European and American. You can only exercise European options on its exercise date and not before, whereas the American-style option can be exercised on any date prior to the expiration date agreed upon.

Conclusion

There are five common forex financial instruments: spot, swap, forward, futures and fx options. Each instrument has its own characteristics, and every trader can choose which instrument to use.

Financial instruments are generally debt or equity-based, but understand as well that forex transactions and instruments are not based on either of the two; they all belong in a different unique category exclusively for forex instruments.

It’s best to understand each and every financial instrument there is to perform well in forex trading. Research is also necessary for better results. Resources are available for your disposal. Forex must be taken seriously as it’s a money making venture – losing and gaining is entirely up to you.

Content source: www.mtrading.ng, A Nigerian Forex broker.