If you trade in the forex market, you probably know that it is the largest trading market in the world in terms of volume. However, did you know that this market is not the only one where you can trade currencies? That's right, you can also trade on the foreign exchange futures market.
Although not as large in volume, forex futures still give you access to forex trading, just from a slightly different angle. Here we will tell you everything about this market, how you can participate in it and what type of assets you can trade here.
Introduction to Currency Futures
The first question you might ask is: what exactly are currency futures? To answer this question, you must first understand futures trading. Futures are basically exchange-traded contracts. Under these futures contracts, you agree to purchase an underlying asset at a specified price at a specific time in the future. When trading futures, you hope that the asset you want to buy in the future will have a better price compared to the contract you purchased.
Foreign exchange futures contracts are traded futures contracts where the underlying asset is the exchange rate of that currency. For example, you can buy a EUR/USD futures contract on the exchange. This means that at some point in the future (when you let the contract expire) you will receive $125,000 in euros. Depending on the exchange rate at that future date compared to what you bought the contract for, you could make a profit by letting the contract expire and receiving the euro worth $125,000. In most cases, however, the futures contracts are regularly re-traded on the market.
Where to Trade Currency Futures?
Many major forex brokers offer spot forex trading (which is what we usually think of when we talk about forex trading) and currency futures. Futures are also offered by almost all full-service brokers.
However, when it comes to the markets you trade in, there is a big difference here. Spot Forex trading is done through your broker on the decentralized Forex market. Trading in foreign exchange futures takes place on exchanges. The largest of these exchanges, and the place where foreign exchange futures were first introduced for trading in 1972, is the CME (Chicago Mercantile Exchange). Trading, like most other futures markets, is also offered on various other exchanges around the world.
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People who trade foreign exchange futures
Anyone can start trading in the foreign exchange market or the foreign exchange futures market as long as they have access to it. Still, futures markets in general are popular markets for many day traders. This also applies to the foreign exchange futures market.
In the example above, we're looking at what happens when your currency futures contract expires and you essentially receive the currency you purchased in the contract. However, the reality is that this process rarely occurs among traders. Instead, the contacts are traded again on the stock exchanges when prices change and speculation occurs on a daily basis. An example of such a rare case where many futures contracts expired was seen in recent months when the price of oil futures contracts went negative. This has resulted in many traders with expired contracts having to take large shipments of oil or attempting to unload the contracts before expiration, resulting in negative prices.
Due to the trading nature of FX futures contracts, you will also likely need access to a little more equity when it comes to start-up costs than if you were trading spot currencies on the FX market.
Differences between Forex and Currency Futures
When trading the foreign exchange market and trading foreign exchange futures contracts, there are some important differences that you should be aware of. Here are some of the most important ones:
The rate: The rate you normally have when trading forex in the usual way is the spot rate. This is the rate at which the currency is currently valued. However, when trading foreign exchange futures, this rate is the forward rate. The forward rate is typically different because it attempts to reflect the price at a later date based on the futures contract. Therefore, you will find that when the spot rate falls, the forward rate usually falls as well and vice versa.
Leverage: When trading forex, you typically have access to very high leverage. Depending on your location, this could be up to 500x your balance. This is not the case with forex futures trading, where leverage tends to be much lower and capital requirements are higher.
Commission: The fees and commissions you have to pay when trading futures are usually significantly higher than those incurred when trading forex. In fact, many Forex brokers allow commission-free trading. However, futures trading requires a commission.
Margin: Because foreign exchange futures contracts have a fixed value, typically around $125,000 per contract, it is common for them to be traded on margin. This means that, depending on the contract, you will have to pay a deposit of $2,500 or more and borrow the rest from the broker. If the contract had actually expired, you would have to honor the contractual payment amount, whereas in Forex trading, many brokers will automatically close positions if your account balance becomes negative.
Final thoughts
If you are interested in forex trading, the forex futures market offers you another excellent alternative that goes beyond forex trading. In general, trading assets in the futures market tends to be a little riskier, and in the case of currency futures, you will need a little more capital to get started. However, with some experience, especially if you are interested in day trading, forex futures could be a good choice.
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