Many people, even experienced traders, think that it’s scary to get involved in the foreign exchange (often called forex or fx) or futures markets. Although they are complex markets, after understanding the respective potentials, benefits, risks, and costs of each, you can make an educated decision about the markets you want to trade on in the future.
In 2016 the forex market averaged $5.1 trillion in daily trading volume. This includes the common exchange of one currency for another. However, this common exchange does not produce the majority of the volume. Forex is traded based in pairs, which are broken down in a base/quote relationship. Among the most often globally traded currency pairs by volume are EUR/USD, USD/JPY, AUD/USD, and USD/CAD.
For example, the current EUR/USD is 1.3333, meaning you would pay 1.3333 U.S. dollars to purchase 1 Euro. If the rate changes to 1.3500, then selling back 1 Euro would yield 1.3500 U.S. dollars.
Forex spot trading is a type of trading using the current rate, which can be compared easily to futures trading.
The Benefits of Trading FX Spot
Some of the greatest aspects of forex trading include the extremely high liquidity, lack of expiration dates, and accessibility of the market. The forex market is open 24 hours a day 5 days a week, from 5 p.m. EST on Sunday until 4 p.m. EST on Friday. This is possible because the forex market is de-centralized and ran by banks globally. Other benefits of the forex market include large leverage factors and fewer fees and commissions.
Brokers may offer very high leverage, even up to 1000x. By putting a total of $50-$100 at risk, that could allow for an effective $50k-$100k notional investment. This opens the opportunity to take large risks in speculation of world markets and earn larger profits. Brokers have highly competitive pricing and are usually cheap. The typical fee is relative to the spread.
The Risks of Trading FX Spot
With increased leverage comes increased risk. Leverage may increase the potential for gains, but likewise, it increases the potential for loss. A second risk is due to unreliable brokers scamming clients. Keep in mind that banks in different countries have different regulations for trading. Knowing these regulations is imperative before choosing a broker. These unreliable brokers can work against the investor and profit from your losses. Finally, with $5 trillion in traded daily forex global volume large players, banks, and hedge funds have a natural advantage at influencing the price.
Futures are a contract made in the present to buy or sell an asset at a future date for an agreed price. Standardized in 1865, all futures contracts must consist of the quantity, delivery date, currency involved, and the unit of measurement of the asset traded. The most traded futures contracts include S&P 500 E-Mini, 10-Year T-Notes, Nikkei 225 Mini, Euro-Bund, and Crude Oil.
These contracts can be exercised at expiration, or the position can be closed out by purchasing the opposite position at any time. If you were purchasing corn and didn’t want the corn anymore, you would need to sell corn at the same delivery date and quantity.
More about futures trading in this post: Futures 101
The Benefits of Trading Futures
The main benefit of futures contracts is that costs are fixed in advance. However, at any point during the length of the contract, you can realize your gain/loss. This is possible due to the freedom of the futures market. You just simply write a contract in the opposite direction and allow them to cancel out. The benefit of the futures market is that due to the large volume, the market is extremely liquid, and you can almost always find someone to take the position opposite of yours. As always, a market involving leverage has the potential for large gains and large losses.
The Risks of Trading Futures
Futures are considered riskier than traditional stock trading due to the high leverage and potential for losses. In futures trading, the price of the asset is determined daily at the close. The profits and losses are then settled among the positions. During this settlement, accounts can expose themselves to the risk of margin calls.
Both forex spot and futures trading provide large leverage towards making trades. Similarly, both markets are open for most if not all of the day during the week, and allow for trading to occur whenever it suits you. They differ in what they trade and in how those assets are valued in a market. Both markets rely on speculation and expose the investor to various risks and benefits.
|Exposure||Global policies and politics||Assets and commodities|
|Market Hours||5pm Sunday – 5pm Friday (ET)||6pm Sunday – 4pm Friday (ET)|
|Price determination||Determined in relation to other currencies||Asset value is determined daily. Contracts state exchange rate for asset.|
|Type of exchange||Centralized exchange across banks||Regulated exchange|
|Broker risk||Unreliable brokers can scam investors. Ensure you select a broker that has your best interest at heart.||Low risk due to the regulation of the exchange. Brokers need to follow the set rules.|