How to Take Advantage of Forex Futures

Every day, many institutions and individual traders exchange currency on the foreign exchange or forex (see resources section for more details). Anytime someone buys or sells currency on forex, they are participating in the spot market. This simply means that they are exchanging one currency for another at the time the trade is made. Although this explanation may seem redundant, there is another way to trade currencies.

Forex futures allow traders to enter into an agreement to buy or sell a currency at a predetermined date and exchange rate. While there are many similarities between the spot market and forex futures, there are also some notable differences between the two. Because of these differences, some people may find it more advantageous to trade forex futures instead of participating in the spot market.

Instructions

1. Step 1

   Compare the spreads. Spreads in forex futures are usually smaller than those in the spot market. Even so, you have to pay a commission when trading futures, so the costs are ultimately about the same. Its still a good idea to look into both options because you may be able to cut costs slightly.

2. Step 2

   Investigate the costs involved with interest rates. When trading currencies, you either pay money or earn money based on the different interest rates of the currencies you’re trading. In the spot market, the amount you pay when you owe money is more than the amount you receive when you are owed money. Additionally, there are some cases where you are charged a fee no matter which side of the equation you’re on. With forex futures, the amount you pay and the amount you earn on any given interest rate difference are equal.

3. Step 3

   Understand the difference in transparency. Although the forex spot market is bigger than the forex futures market, spot forex is actually a fragmented market involving many parties with various levels of access to prices and information. Also, if you’re trading spot forex through a dealer, you are effectively trading against that dealer because they automatically take the other side of any trade you make. This doesn’t necessarily mean that unethical activity is taking place, but it certainly provides some incentive for unscrupulous dealers to engage in such activity.
   
   On the other hand, forex futures are traded over several central exchanges including the Chicago Mercantile Exchange (CME) in the US. This setup provides two distinct advantages over the spot market. First of all, you are not ‘trading against the house’ like you would be with a dealer. Second, because trading takes place over centralized exchanges, it is much easier for traders to obtain accurate information on statistics such as volume and open interest.

4. Step 4

   Use forex futures to hedge yourself against unwanted currency fluctuation. For example, if you’re doing business in another country, you can establish a futures contract in the appropriate currency pair. This will protect you against potential losses resulting from changes in the exchange rate.

Tips & Warnings

• While there are notable differences between the spot market and the futures market, trading either one involves a substantial amount of risk.