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NO05 - Why Trade Forex: Forex vs. Futures

"At some point, every forex trader asks the question whether they should trade forex or futures? The markets look the same for the layman, but there are some subtle differences. Some might prefer to trade futures, while others prefer the forex markets. In this article we explain to you the difference between the forex markets and the futures markets. You will get a deeper understanding of how these two markets, which basically rely on the same underlying instrument can vary so much. The futures markets are widely popular in the United States. But if you are a trader from elsewhere, you might be left scratching your head as to which of these two markets are better to trade. Remember that every type of financial market is unique and designed for a purpose. Therefore, there is no “best market” that is available for you trade. By the end of this article, you will learn about the differences and then judge for yourself whether you should trade forex or futures."

Should you trade forex or futures? For that matter, what is the difference between the forex markets and the futures markets? In this section will we will outline the key differences between these two markets. By the end, you will have a good understanding of the difference between these markets.

Have you heard about the futures markets? Perhaps you have traded futures and wonder how different it is to the forex markets.

There are some fundamental differences between the forex and the futures markets. In this article, we explain what futures contracts are, and then explain the differences between the forex and the futures markets.


What are futures?

Futures or futures contracts are derivative contracts. The name derivative contracts come from the fact that the price of futures contracts is derived from something else. You might wonder how this is possible.

Well, simply put, futures contracts and other derivative products are not actual tradable contracts. The price in the futures market is based on the spot or the current price in the markets. Futures markets are used mostly by commercials; also known as producers or consumers.

In a futures contract, the buyer and the seller agree to a price for which, the delivery of the underlying asset or security is given at a future date.

Take the example of Starbucks.

Starbucks primary business is that to make coffee. Thus, Starbucks is a consumer of coffee beans. But who sells these coffee beans to Starbucks? It is the coffee farmer. Therefore, the farmer is basically the producer of coffee beans.

But as you know, price of a commodity can change on a daily basis. There is a need on either sides, to lock in a price. Therefore, futures contracts are used here to lock in a selling price for the producer and a buying price for the consumer.

This helps to prevent both the parties to avoid the volatility in the price of coffee beans.


How do futures contracts work?

Futures contracts as bilateral agreements between the buyer and the seller. The contracts are agreed upon and traded at an exchange. Typically, at the end of the contract period, the seller will give the buyer the underlying asset. Whereas, the buyer will pay the fee at the start of the contract.

The above use of a futures contract is what is known as hedging. Both the producer and the consumer are hedging the volatility of the coffee bean prices by agreeing to a fixed price for a fixed amount of goods.

Now a days, the futures markets are also made up of speculators. The speculators are there only to take advantage of the volatility of the futures prices. Contracts are closed out before they expire in order to avoid taking delivery of the underlying. This way, the contract buyer or the seller simply settle for cash.

Futures are a great way to not only hedge but also speculate as outlined in the above example.

Futures are not just limited to physical commodities but a lot more. There are different types of futures such as precious metals, oil, currencies, financials, interest rates, agriculture, etc.

One of the main differences in the futures markets is that the contracts roll every three months or a quarter.

The futures contracts are primarily broken into contracts based on months. Each of these months are then assigned a letter.

These are also known as the futures contract month codes.

Contract Month Month Code
January F
February G
March H
April J
May K
June M
July N
August Q
September U
October V
November X
December Z

 

The futures contract symbols are made up of the Commodity or the underlying asset, the month and the expiration. For example, a ticker E6M19 means a Euro currency future which will expire in June 2019.


Difference between Forex and Futures

 

Forex Futures
Forex markets are spot markets, meaning that the price you see is the actual price Futures prices are based or derived from the spot markets
Spot forex markets are continuous. There is no gap Futures contracts come with an expiry. All futures expire either in March, June, September or December
Physical settlement in the spot forex markets is T+2 Settlement in the futures markets is done T+2 after expiry
Trading spot forex allows you to trade on leverage and margin, as much as up to 1:500 Futures contracts can also be leveraged, but this is limited to the type of futures contract that you trade. By all means, leverage is less in futures markets
Spot forex is traded over-the-counter Futures contracts are traded and settled at a futures exchange
There is a counterparty default risk with spot markets as trades are OTC There is no risk of default as participants need to post collateral on a daily basis, known as mark-to-market

 

To conclude, the futures markets were designed to address a specific need for market participants. They are primary vehicles for producers and consumers. But in recent times speculators have also started trading futures.

Because forex trading is prohibited in some countries, traders take to trading the futures currency contracts which is an alternative.

Read 669 times Last modified on Friday, 03 May 2019 17:55

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