Micro FX futures – Understanding the FX market
The foreign exchange market ‒ sometimes referred to as the currency market, Forex, or simply the FX market ‒ is huge, global, and very fragmented. FX transactions can be conducted by large global banks, regional broker, or dealers and even small, unregulated boutiques. Exchange-traded and cleared FX products have contributed to the growth of this market. This is due to the highly transparent nature of FX futures contracts and the safety that is derived from central clearing and post-trade risk collateralization, which reduces counterparty risk.
When trading FX products, one should be aware of the economic theories of exchange rates – such as Purchasing Power Parity (PPP) and Interest Rate Parity (IRP) ‒ plus other theories, such as the Big Mac Index.
Currencies are identified by three-letter codes that are now an international standard. These codes are used in the Micro FX quoting conventions which are currencies quoted in relation to another currency. The first currency in the quotation is known as the named or base currency, and the second currency is known as the terms or quote currency.
Additionally, currency pairs versus US dollars tend to be quoted in one of two ways, in either American or European terms. American terms are currency pairs where the quote convention places the USD in the terms location. European terms mean the US dollar sits in the base currency location and the other currency occupies the terms position.
When trading Micro FX futures, market participants need to be aware of the quoting convention and the trading code symbols for each currency pair offered by the exchange.