The Trade Life Cycle in Capital Market Overview
Forex Blog Articles
A peek behind the curtain to understand how forex trades are actually being made
The trade life cycle is the sum of all of the steps from the initial trade order to the eventual settlement which make up the active life of a capital market trade.
Beginning with order and ending with trade confirmation and validation, the journey of a forex trade from conception to realization may not take long timewise, but it will pass through six key stages before it comes to completion.
From the outside it may look like a trade is a very straightforward swap between two parties, but in actuality, there is far more going on than it seems. Let’s take a look at exactly what’s going on behind the scenes
What Is the Trade Life Cycle Process?
In the capital market, the trade process is the set of events and actions that occur once there is a purchase or sale of any financial asset. The first step in this process is the order.
Step One: The Trade Order
After an investor has spotted a lucrative opportunity in the market, they inform their broker and bank of the trade they would like to make and at what price they would like to make it. This first step is called the buy order and it can be placed at the market price or lower. An investor may also place a limit order which indicates that he or she would like to buy or sell at their specified price or higher.
After the order has been placed, the order moves into the second phase of the cycle which is referred to as front office action.
Step Two: The Brokerage House and Risk Management Check
A front office sales trader now receives the investor’s order. They take the order and send it over to risk management specialists in the brokerage firm. At this point, the sales traders execute the order.
From here the risk management specialists take over.
In order to determine whether the order fits within the risk management parameters, risk managers in the brokerage house now conduct checks and calculations before the trade can move to the next step. In determining whether the trade is safe to make, one of the things they look at is whether or not the investor placing the order has sufficient capital in the forex market to cover the security and limits.
Once the order passes this examination it is then ready to move on to the third stage, a trip to the exchange.
The Order Makes its Way to The Exchange
Step Three: Let’s Find a Match
With the seal approval from the brokerage house’s risk management department, it’s time for the order to move on to the foreign exchange. Note that when an order to buy is sold, so too will an order to sell from someone who has the currency to sell. The sell side order has to go through the same risk management procedure until it is then sent to the exchange.
After the order has been sent to the exchange, it’s time to find a match for the order.
When anyone places an order to purchase an asset, the only way for the trade to come to fruition is if there is someone on the other side looking to sell that asset. It is at this time that the exchange searches around for the perfect other half to match the trade order with.
Once this ideal match has been realized, a trade finally materializes and we jump right into the post trade process.
Step Four: Confirming the Trade and the Post Trade Process
A match has been made and the exchange immediately delivers the pertinent information to the brokers for confirmation. Now it’s time for the brokers to let their client know that the trade has been born.
And with the notification of the match in orders, it’s time for the confirmation phase.
Even after all of the previous steps, the trade that is now actualized still needs to be confirmed. Brokers on both sides of the trade (the buyers and the sellers) will make sure their clients agree with the specifics of the trade. These details include which securities are being exchanged, at what price, and at which date the settlement will occur.
Once all the specifics have been accepted by their clients, the brokers will pass the trade to their back office teams and pave the way for the clearing house portion of the newly confirmed trade.
Clearance Time Begins
Step Five: The Clearing House
Once the trade is in the clearinghouse, it’s time to calculate exactly what is needed from each side of the trade. The trading house then informs both sides of what is needed. It’s also the job of the clearing house to ensure all of the obligations are met by both sides.
At this phase, trades are given a letter and number in order to quickly reference them. The most common way to trade is T+2, in which T stands for the transaction date and 2 represents the number of days after the transaction date in which the settlement will take place. In the case of T+2, it means the settlement will take place 2 days after the transaction is made.
Moving its way through the clearing house, now it’s time for a trade to experience the final stage in this journey, the settlement phase.
Step Six: The Settlement
Usually two days after the transaction date, the settlement date finally comes. This is the day in which the currency pairs are officially exchanged between the two parties. However, the transfer does not occur directly between the two traders. The clearing house will receive the securities or money and move them into accounts they have set up for their respective clients.
At this final step, the clearing houses deliver detailed reports to their client and the trade life cycle is complete.
Trade Life Cycle in Capital Market Summary
The trade life cycle in capital market mechanism that executes thousands of trades from second to second, and millions from day to day, is a finely tuned and well oiled machine that relies on quick and seamless action to deliver and keep up with the demands of buyers and sellers.
Next time you make a trade or consider making a trade in the forex market, take a moment to consider all of the incredible steps that happen from beginning to end. The sheer amount of trades which are placed on a daily basis makes this life cycle somewhat remarkable.
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