Pick your instrument

An instrument is any medium used for borrowing purposes on a financial market. On the foreign exchange market, there are a number of different instruments that traders use. Forex trading can get a bit complicated, so we’ll just go over the basics here.

Spot. A spot is one of the most commonly used instruments on the foreign exchange market. It’s an agreement between two parties to buy or sell a currency at the current exchange rate—a simple exchange of one currency for another. Let’s say you have $1,000 and want to buy Australian dollars. The current exchange rate is:

USD / AUD = 1.37

A spot agreement between you and another trader on the forex (who owns Australian dollars) means that you will give her/him your $1,000 (USD) in exchange for $1,373 in Australian dollars. The transaction will take place within 48 hours and will involve cash only. Learn more about the spot trade by reading this informational article Links to an external site. from Investopedia.  

Forward. A forward is a contract between two parties to buy, sell, or trade currency at an agreed-upon rate. This rate is not necessarily the same as the current exchange rate. There is no transfer of money between the two parties until the agreed-upon date. Traders use forwards to minimize their risk—by locking in a rate ahead of time, they avoid any potential volatility on the forex. 

The most common type of forward is a swap. In this arrangement, two parties trade currencies for a certain length of time, then “swap back” at an agreed-upon date in the future (it might even be 30 years from now!). Currency swaps do not use standardized contracts, and they are not traded on the exchange market. Instead, they are private contracts between two parties.

Another type of forward is called a future. A future uses a standardized forward contract and usually has a maturity date of three months. This means the currency exchange takes place three months after the two parties agree to an exchange rate. Futures are traded on designated markets, such as the Chicago Mercantile Exchange.

Option. An option, also known as an FX option, is an agreement between two parties in which the owner of the option has a right—but not an obligation—to exchange one currency for another at an agreed-upon rate on an agreed-upon date. The owner of the option pays a premium to purchase this right. As a trading instrument, an option offers a way for traders to minimize some risk. You can read more about options here. Links to an external site.