Futures trading is a financial instrument used by traders to speculate on and hedge against the fluctuations in currency prices. While this is like “spot” forex, the most popular form of forex trading, futures differ in that they feature a contract that obligates the buyer and seller to complete a transaction at a specific time and for a set price later.
When trading assets on financial markets, it’s essential to understand the distinction between different instruments. With full knowledge of the investment options available, you will have a better chance of making the right decisions for your circumstances and portfolio. Reading articles about different aspects of forex and reputable brokers will also help you to avoid forex scams.
Both “normal” forex trading and futures have distinct features and pros and cons that must be weighed carefully. Futures are a derivative financial instrument, a term used for a contract between two parties for an underlying financial asset. The value of this contract is derived from the asset’s value which, in this case, is the currency. All futures have a termination date written into the contract. At this point, the transaction must take place with the currency changing hands for the set price.
This process is different from spot forex, where traders buy and sell currency pairs as and when they see fit. Standard forex trades take place across global markets, and each currency can, in theory, be traded in perpetuity. This differs from futures where the expiration date is set in stone and ends after it has passed, and the transaction has been completed.
However, futures can be bought and sold multiple times when the contract is “live.” Futures are generally scheduled to expire at specific points during the year. Contracts are no longer listed and taken off the board when this occurs. After expiration, futures are most commonly feature a cash settlement.
Another important distinction is that the value of spot cash forex trades is based on currency pairs alone. When you start trading for the first time, you will probably opt for major pairs such as GBP/USD and EUR/USD. This is still the case for forex futures, but they are priced independently, with the value based on the currency pair’s spot rate in addition to an interest differential.
What are the benefits of futures?
Futures are used primarily for hedging and the desire to limit exposure to the volatility of currency prices and to lock in a price and thus, reduce risk. The aim is to generate profits, just like spot forex, but the methodology is slightly different. Traders can still go either long or short with futures and select a market of their choosing based on fundamental and technical analysis. And while contracts expire, it is still possible for traders to exit them before the end. That is where instruments like stop losses can help.
What are the drawbacks of futures?
While futures allow investors to conduct trades in a more regulated atmosphere than the cut and thrust of standard forex, there are several potential downsides. The leverage that a trader can use to increase the size of their bets is limited compared to standard forex, which may be a problem for new traders with limited funds. The contracts themselves are complex, including features such as pricing, trading hours, specifications, and end dates. There can also be periods of extreme volatility, though that is also true for forex.
What are the main uses?
As already noted, hedging is a popular outlet for futures, with larger corporations more likely to opt for them than smaller retail investors. A company might want to use futures to reduce the currency risk of receiving a large payment in six or twelve months. By taking a contract, the company can hedge against a particular currency and potentially mitigate the losses of a trade if it had been completed at the spot rate.
Traders also use futures to speculate, with this also being popular with individual investors. Depending on a trader’s technique and the frequency they want to enter and exit the market, it may make sense to use futures as another tool to supplement standard spot trading. Futures are open to all and can be traded by opening a CFD or spread betting trading account. They are now standardized, so they are easier to get into than in the past. To conclude, both spot forex and futures could work for you, and it is very much dependent on your financial circumstances, trading style, and strategy.
