Online trading involves buying and selling financial instruments, similar to FX Structured Products, via an online platform. The online platform is a service offered by a broker or a registered financial institution; for instance, a bank. To benefit from online trading, you need to know your way around the platform. The various terms and their meanings.
This article walks you through the main trading instruments; explaining what they are and why they matter in your online trade.
What are trading instruments?
Trading instruments is a phrase used to refer to the different markets available for online traders. There are several trading instruments in a market. They may include securities, stocks, currencies, and CFDs.
Currencies are the main instruments of a foreign exchange market: that is, the currency combinations of various countries. It may, for instance, be against the US or Australian dollar. Currency combinations vary in accordance to the forces of demand and supply within the forex market.
Trading instruments can be classified into two categories.
Derivatives
In simple terms, derivatives are financial instruments that are drawn from an underlying asset. Some of the financial instruments that fall under derivatives are:
Currency futures
Currency futures refers to predetermined transactions that provide the exchange of currencies for a future date on an online trading platform.
They are future contracts that state the ‘future’ price of a currency in another currency. This instrument is used as a protective measure for traders receiving payments in foreign currencies. Because a currency future is a legally binding document, parties who enter into this agreement must honor the specified prices on the delivery date.
Currency options
A currency option is the agreement made when a buyer and seller agree to buy a specific amount of a said currency at a predetermined cost within a specific timeframe. To validate this agreement, the buyer makes a premium payment to the seller.
Buyers and sellers who enter into a currency options agreement stick to it irrespective of the prevailing market prices.
This trading instrument is used by traders who are concerned about the possibility of unpredicted variations in the exchange rates.
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Synthetic agreement for foreign exchange
Popularly referred to as SAFE, this trading instrument is a prior agreement on the future exchange rate for a certain period.
A SAFE operates more like a currency future; the main difference is that there’s no currency delivery with a SAFE. With this tool, the transacting parties settle the profit or loss on a hypothetical amount of a currency.
The SAFE settlement is made in US dollars.
Let’s now switch gears and look at currency instruments
Currency instruments in the foreign exchange market
Currency swap
A currency swap happens when transacting parties exchange equivalent amounts of money in different currencies. Here, the transacting parties agree to repay the exchanged currencies at a certain date.
This instrument protects traders (buyers) from high rates that may result from instability in a currency. It also helps avoid the costs associated with loaning in foreign currencies.
Spot
This instrument refers to trading agreement that requires the exchange of currencies to be executed within two (working) days of an agreement. Over 60% of forex trading is done on an over the counter basis and is based on spot conditions.
The prevailing exchange rate at the time of transaction is known as spot exchange rate.
Outright forwards
Outright forwards are the trading instruments to go for when there are currency exchange rate instabilities or fluctuations. This option allows you to exchange your currencies at a forward rate as long as it happens within a specific number of days.
Conclusion
The number of investors penetrating the foreign exchange market has been on the rise. The availability and accessibility of online trading platforms such as eToro have contributed to this spike. With the availability of the discussed trading instruments, you too can revolutionalize your trading experience.
We hope that this guide will help you make the most of the online trading platforms and that you will realize more returns from this worthy investment.