What is a Futures Contract?

By ForexBrokers · Filed Under FAQ Leave a Comment 

When it comes to trading Forex or currencies, most people would trade in the spot market by default. It’s really quite rare to trade currency futures, but there are certain advantages of trading futures as opposed to spot.

By definition, a currency futures contract is an agreement between two counter parties to exchange one currency for another at a specified future date at a price fixed on the purchase date.

Typically, futures contracts are settled a few months from the purchase date, but of course you can close out the contract at any time prior to the settlement/delivery date.

You can purchase currency futures for any pair that is traded on the spot market, so you’ll be able to find EUR/USD, USD/JPY and even NZD/JPY futures contracts. Typically, these futures contracts are traded on exchanges, such as the Chicago Mercantile Exchange (the largest futures exchange in the world). In this article, we will explore the advantages and disadvantages of trading currency futures as opposed to spot FX.

The Advantages Of Trading Currency Futures

The biggest advantages of trading currency futures is that they are regulated by the exchange they are traded on. On the CME for example, every trader, whether retail or institutional, has the same access to the market and prices on offer. On the other hand, on the spot market, there isn’t a centralized price, and there are often private deals being negotiated that can drastically affect the market prices when the orders hit the market.

When you trade currency futures, you are protected from the questionable practices of the interbank market, such as brokers taking the other side of your trades and offering you a different price compared to what you would have been able to get elsewhere. Because the interbank market is global and decentralized, it is not subject to any kind of regulation. Therefore, brokers and other market players have free reign to do as they please, subject to the laws of the country they are based in.

In other words, when you’re trading in the spot market, you’re on your own. It’s up to you to ensure that you’re getting the best prices and the best deal from your broker, especially if you’re dealing with brokers that are based in a foreign country. When you’re trading currency futures, you’re protected by the exchange you are trading on, and everything is regulated so you know you’re getting the best prices and the best deal available.

The Disadvantages Of Trading Currency Futures

While exchange based trading has its advantages for trading currency futures, it does have some serious disadvantages as well. For one, you’re subject to the trading hours of the exchange. If you are a position trader holding your trades overnight, you will be subject to the risk of your trades moving against you significantly without the ability to close out your trades. Because the spot market operates 24 hours a day, there is a real risk of the markets moving a few hundred pips one way or the other while the exchange is closed. This is of very serious detriment to any longer term Forex trader.

Another major downside of trading currency futures is that you can only trade in fixed contract sizes of 100,000 units of the underlying currency. That means that you will have to have a significant amount of capital to start with to ensure that you’re adequately capitalized for the ups and downs of trading. In the spot market, you can take mini or even micro positions, so even if you have a few thousand dollars to start with, you’ll definitely have enough to get started and build up your stake.

All in all, I would still recommend trading on the spot market, especially if you need to hold your positions overnight or trade smaller lots. While currency futures may offer more transparent and centralized pricing, at the end of the day it will still follow the spot prices because of market forces and arbitrageurs. From now until the foreseeable future, retail traders are still living in a spot FX world.

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