The benefits of forex over currency futures trading are considerable. The dissimilarities between the two instruments range from philosophical realities such as the history of each, their target audience, and their relevance in the modern forex markets, to more tangible issues such as transactions fees, margin requirements, access to liquidity, ease of use and the technical and educational support offered by providers of each service.
The forex market is a very large market with many different features, advantages and pitfalls. Forex investors may engage in currency futures as well as trade in the spot forex market. Many who become interested in foreign exchange trading wonder what the crucial differences between spot forex and currency futures are. While both forms of trading involve making decisions regarding the future prospects of global currencies there are a number of subtle differences traders should take note of before deciding which product is suitable for them.
Currency futures trade in a completely different manner than the cash foreign exchange market where trading is done primarily in the spot and forward markets over an electronic and telephone network. The currency futures market has grown considerably since their introduction on the International Monetary Market division of the Chicago Mercantile Exchange in the early 1970s. Before the rise of online retail forex trading in recent years, trading currency futures on the Chicago IMM was one of the few ways that individuals could trade currencies in smaller amounts.
A futures contract is a legally binding contract that obligates the two parties involved in a deal to trade a specified amount of a currency pairing at predetermined price at some point in the future. A seller of a contract will profit if the currency pairing is trading below the predetermined price in the spot market at the time of expiry. A buyer of a contract will profit if the currency pairing is trading above the predetermined price in the spot market at the time of expiry. The futures markets are dominated by multinationals companies who need to hedge their foreign exchange risk and by large speculative traders who enter into the markets with the goal of turning a profit.
Spot forex differs as the underlying currencies involved in a deal are exchanged immediately when a trade is successfully placed. Rather than waiting for the expiry date a trader will typical buy or sell a specific amount of a currency pairing immediately. This allows for traders to immediately profit off any fluctuation in currency prices. Whenever someone goes to change up one currency into another currency they are participating in the spot market. In addition to foreign exchange, precious metals tend to be traded as a spot instrument.
Forex vs Futures Differences
The main difference between currency futures and spot forex is when the trading price is determined and when the physical exchange of the currency pair takes place. With currency futures, the price is determined when the contract is signed and the currency pair is exchanged on the delivery date, which is usually some time in the distant future. In the spot forex, the price is also determined at the point of trade, but the physical exchange of the currency pair takes place right at the point of trade or within a short period of time thereafter.
- 24 Hour Trading
In the forex market, $5.3 trillion is traded daily, making it the largest and most liquid market in the world. This market can absorb trading volume and transaction sizes that dwarf the capacity of any other market. The futures market trades a puny $30 billion per day. The futures markets can’t compete with its relatively limited liquidity. The forex market is always liquid, meaning positions can be liquidated and stop orders executed with little or no slippage except in extremely volatile market conditions.
Another advantage the forex trading compared to futures trading is the fact that you can trade 24 hours a day, five days a week if you want. The forex market is open longer and for more hours than any other market. If a person is serious about making money in a market, it sure would be nice to have virtually unlimited time each week to make those trades. Whenever some event happens around the world, you can be one of the first to take advantage of the situation. You won't have to wait for a market to open in the morning.
One of the primary draws of retail accounts to forex is the idea of commission free trading. Forex brokerage firms working with a dealing desk make money on the fixed pip spread offered to clients, but don’t charge a commission. On the surface, this seems to offer discounted transaction costs relative to the futures market. However, it is important to note that the typical forex pip spread of 3-5 pips provides the brokerage firm with a handsome reward.
Online forex trading gives you much greater leverage than playing the Futures Market. However, in the Futures Market, you can also buy or sell options on futures, which increase your leverage. Leverage can be very important when you know what a currency is going to do. You can achieve 200:1 and greater in forex trading compared to much less in futures trading. This means a lot more potential profit, again if you make the right moves.
Both Spot Forex and Currency Futures have their own pros and cons. Those who favour currency futures as a trading instrument tend to place significant emphasis on transparency and regulation. While those singing the praises of Spot FX tend to concentrate on the liquidity and leverage. It should be noted that the Spot Forex is more accessible to the average retail trader and accessing the currency futures market can certainly be a challenge. The fact that the Spot Forex market can be so easily accessed partly explains the rapid growth that the retail spot market has experienced in recent years. Both forms of trading involve significant amounts of risk and those unsure whether trading is for them should seek the advice of an independent financial adviser.