What is a Buying Forward
Buying forward is an investment strategy that involves the buying of money market instruments, commodities, or other physical or financial assets in anticipation of a price rise or a future increase in demand.
When anticipation of a rise in security prices exists, or an increase in the demand levels for a particular good, buying forward allows an investor to take advantage of future and potential profits by buying now, at a lower price, and selling when prices rise.
BREAKING DOWN Buying Forward
The opposite of buying forward is selling forward. If an investor believes that the price of a security or the demand of a currency is going to drop, selling forward can help the investor mitigate loss because he or she is selling now, while the price is still high, as opposed to selling at a loss when prices drop.
The mechanics of buying forward include the purchase of a forward contract. This is a customized contract between two parties that specifies the asset to be purchased at a later date, along with the agreed-upon price.
Forward contracts can have a strong impact on a local or regional market for a particular good. For example, in April 2018 in Western Australia, the Department of Primary Industries and Regional Development’s Sheep Industry Business Innovation project held opening day discussions into new technology and market updates to the sheepmeat industry, including setting forwards contracts. Such arrangements and contracts were deemed essential to managing the sheepmeat supply. At present, the sheep market in the region functions primarily on spot, or short-term marketing, which offers less room for planning.
Buying Forward Versus Buying Futures
In contrast with standard futures contracts, a forward contract can be customized to any commodity, amount, and delivery date, and is generally a private arrangement. This makes forward contracts less readily available to the retail investor than futures contracts. Because forward contracts do not generally trade on public exchanges, they are considered over-the-counter (OTC) instruments.
While futures contracts are standardized, trade on major exchanges, and have clearing houses that guarantee the timely and complete delivery of the transactions; forward contracts lack a centralized clearinghouse and therefore can pose a higher degree of default risk.
Forward contracts settle on one date at the end of the contract, while futures contracts can settle over a range of dates. In addition, a forward contract settlement can occur on a cash or delivery basis.