When it comes to forex trading systems, market participants are not limited to trading spot or forward forex, they can also choose to trade Forex Futures (also known as currency futures). So what are forex futures, how do they differ from the spot and forward markets, and what are some of the main reasons they are traded?
Definition – What is a Forex Future?
First, some Investment Basics. A forex futures contract is an agreement to buy or sell a predetermined amount of one specified currency versus another at a pre-determined date in the future. Future forex trading is performed on regulated exchanges, the largest of which is the CME, the Chicago Mercantile Exchange. The exchanges determine the contract size, the delivery date, the trading hours, the final settlement rules and the deposit (or margin) that buyers and sellers must pay when opening and maintaining a trade.
For example, say I wanted to buy one lot of December CME Euro FX Futures at the current market price (e.g. 1.0950), what am I actually doing? In effect, I am agreeing to buy 125,000 Euros (the contract size) for delivery on a specific date in December (the delivery date) at a rate of 1.0950, regardless of what the Euro/USD rate is on that date in December. If the Euro/USD exchange rate in December is higher I have made money. If the rate has dropped lower I’ve lost money.
As currency futures can be bought and sold any time up to the last trading date, I can trade out of my position and not take it to delivery (this is what actually happens most of the time).
Key Differences Between Currency Futures & Spot/Forward Forex
There are a number of differences between currency futures and the cash forex market. First of all, forex currency futures are traded on regulated exchanges (e.g. CME) whereas cash forex is traded “over-the-counter” or OTC. This means that forex futures are cleared through a central counterparty, the exchange clearing house instead of directly with the bank or other institution who deals with you in the cash forex market.
Typically you would pay commission to trade currency futures, whereas with the cash market you only pay the spread (the difference between the buy and the sell price).
You can only trade forex futures during the exchange-specified trading hours, whereas the cash forex market is 24-hour, has much more liquidity (the forex market is the most liquid market in the world) and has unrivalled speed of access.
Opening a forex futures account usually requires a higher up-front deposit than a spot forex account, because you need to be able to cover the exchange/clearing-house margins.
Why Trade Forex Futures?
Given some of the disadvantages highlighted in the previous section, you may wonder why anyone would choose to trade forex futures instead of trading the cash forex market. There could be a number of reasons.
Hedging. Firms who have any kind of forward foreign exchange exposure (e.g. exporters who are paid in another currency) might wish to lock in a currency rate to prevent adverse impact from future currency fluctuations.
Standardised contract terms. Having standard contract sizes, delivery dates, etc, can simplify transactions
Central counterparty. As the exchange clearing house takes the other side of every trade, there is less counterparty risk than when dealing direct with another institution.
Lower spreads. Although currency futures transactions incur a commission payment, bid/ask spreads are typically lower than they are in the cash forex markets for individual investors. This is because there is always an official “best bid/ask” on exchange-traded futures, whereas in the cash market, a counterparty can quote you whatever they like.
Leverage. Probably one of the main reasons futures and other derivatives are traded is because of leverage. You pay a deposit (initial margin) to cover any initial adverse movements against you, but if the price moves in your favour, you stand to gain much more than you would if you invested the same amount of money in the cash forex market. The downside of this situation is that leverage works both ways – if the price continues to move against you, thenyou will be faced with a margin call to pay additional funds (variation margin) to cover further adverse movements.
Conclusion
Currency futures offer an alternative to cash forex trading, but should only be considered in certain circumstances. By offering this introduction to forex futures, explaining some of the key differences between the futures and cash markets and explaining why market participants trade forex futures, we hope we have given you a better understanding of where futures fall in the whole forex trading systems equation.
Please remember that if you decide to trade Forex Futures, you are at risk of losing money, so never invest more than you can afford to lose. Happy trading!
{ 1 comment… read it below or add one }
Good post.
Now, beam me make a comment? I listened and I see some pages that are robots to assist us in the trends of Forex. Also found a good page with reviews about: http://tr.im/forexrobot
The question is: (yes, I’m beginner) The use of such programs is allowed? Do you use them? Compensates pay for it? Hugs!