One derivative of the forex market is the forex futures market, which is only 1/100th the size of the currency market. Read on to examine the key differences between forex futures and traditional futures and looks at some strategies for speculating and hedging with this useful derivative.

Forex Futures versus Traditional Futures

Both forex and traditional futures operate in the same basic manner: a contract is purchased to buy or sell a specific amount of an asset at a particular price on a predetermined date. (For an in-depth introduction to futures, see Futures Fundamentals.) There is, however, one key difference between the two: forex futures are not traded on a centralized exchange; rather, the deal flow is available through several different exchanges in the U.S. and abroad. The vast majority of forex futures are traded through the Chicago Mercantile Exchange (CME) and its partners (introducing brokers).

However, this is not to say that forex futures contracts are OTC per se; they are still bound to a designated 'size per contract,' and they are offered only in whole numbers (unlike forward contracts). It is important to remember that all currency futures quotes are made against the U.S. dollar, unlike the spot forex market.

Here is an example of what a forex futures quote looks like:

For any given futures contract, yur broker should provide you with its specifications, such as the contract sizes, time increments, trading hours, pricing limits, and other relevant information. Here is an example of what a specification sheet might look like:


Specification Sheet from CME

 

Hedging versus Speculating

Hedging and speculating are the two primary ways in which forex derivatives are used. Hedgers use forex futures to reduce or eliminate risk by insulating themselves against any future price movements. Speculators, on the other hand, want to incur risk in order to make a profit. Now, let's take a more in-depth look at these two strategies:

 

Hedging 

There are many reasons to use a hedging strategy in the forex futures market. One main purpose is to neutralize the effect of currency fluctuations on sales revenue. For example, if a business operating overseas wanted to know exactly how much revenue it will obtain (in U.S. dollars) from its European stores, it could purchase a futures contract in the amount of its projected net sales to eliminate currency fluctuations.

When hedging, traders must often choose between futures and another derivative known as a forward. There are several differences between these two instruments, the most notable of which are these: 

• Forwards allow the trader more flexibility in choosing contract sizes and setting dates. This allows you to tailor the contracts to your needs instead of using a set contract size (futures).

• The cash that's backing a forward is not due until the expiration of the contract, whereas the cash behind futures is calculated daily, and buyer and seller are held liable for daily cash settlements. By using futures, you have the ability to re-evaluate your position as often as you like. With forwards, you must wait until the contract expires.

 

Speculating

Speculating is by nature profit-driven. In the forex market, futures and spot forex are not all that different. So why exactly would you want to participate in the futures market instead of the spot market? Well, there are several arguments for and against trading in the futures market:

Advantages
• Lower spreads (2-3).
• Lower transaction costs (as low as $5 per contract).
• More leverage (often $500+ per contract).

Disadvantages
• Often requires a higher amount of capital ($100,000 lots).
• Limited to the exchange's session times.
• NFA (National Futures Association) fees may apply.

The strategies employed for speculating are similar to those used in spot markets. The most widely used strategies are based on common forms of technical chart analysis since these markets tend to trend well. These include Fibonacci studies, Gann studies, pivot points, and other similar techniques. Alternately, some speculators use more advanced strategies, such as arbitrage.

 

Conclusion

As we can see, forex futures operate similarly to traditional stock and commodity futures. There are many advantages to using them for hedging as well as speculating. The distinguishing feature of forex futures is that they are not traded on a centralized exchange. Forex futures can be used to hedge against currency fluctuations, but some traders use these instruments in pursuit of profit, just as they would use futures on the spot market.

Forex Options

Related Articles
  1. Investing

    Introduction To Currency Futures

    The forex market is not the only way for investors and traders to participate in foreign exchange.
  2. Trading

    Forex Trading: A Beginner's Guide

    Learn about the forex market and some beginner trading strategies to get started.
  3. Trading

    Top 5 Forex Risks Traders Should Consider

    With a long list of risks, losses associated with foreign exchange trading may be greater than initially expected. Here are the top 5 forex risks to avoid.
  4. Trading

    Introduction To E-Micro Forex Futures

    At one-10th the size of regular FX contracts, the E-micros offer traders the opportunity to trade the forex in a regulated marketplace with reduced risks.
  5. Trading

    Should You Trade Forex Or Stocks?

    Deciding which markets to trade can be complicated, and many factors need to be considered in order to make the best choice.
  6. Trading

    The Pros And Cons Of Trading Forex In An Overseas Account

    The Dodd-Frank Act of 2010 could impact whether overseas accounts benefit FX investors.
  7. Trading

    How to Build A Forex Trading Model

    Forex trading markets work 24/7, providing ample opportunities to make profitable trades. How can you build a profitable forex trading model for yourself?
  8. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  9. Trading

    Futures Fundamentals

    For those who are new to futures but want a solid understanding of them, this tutorial explains what futures contracts are, how they work and why investors use them.
Frequently Asked Questions
  1. Why Do Most of My Mortgage Payments Start Out as Interest?

    Fear not: Over the life of the mortgage, the portions of interest to principal will change.
  2. What is the difference between secured and unsecured debts?

    The differences between secured and unsecured debt, and how banks buffer risks associated with each type of loan through ...
  3. How Many Times has Warren Buffett Been Married?

    Warren Buffett has been married twice in his life, but the circumstances surrounding the marriages were unconventional.
  4. What's the smallest number of shares of stock that I can buy?

    Many people would say the smallest number of shares an investor can purchase is one, but the real answer is not as straightforward. ...
Trading Center