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A futures contract is a contract made between two parties—a buyer and a seller—for an underlying asset to buy/sell on a specific date in the future at a specific price. It is considered a derivative security. In currency futures, currencies can also be termed underlying assets and traded as contracts.
Currency futures are derivative securities through which an underlying currency is hedged for another currency. For example, the Swiss Franc is being hedged against the US Dollar. Apart from this, there is no differentiation between currency futures and other futures markets. To understand currency futures, you need to understand its basics, one of which is the difference between currency futures and the forex market. The forex market is not regulated, and trades occur via brokers, whereas the currency futures are traded on exchanges like the Chicago Mercantile Exchange (CME).
Currency traders decide whether to enter the currency market or currency futures based on their requirements, skills, and knowledge. They must understand what both markets are based on, how they work, how the margins work, and other related matters.
Understanding Currency Futures
As stated above, currency futures depend on the exchange rates of two currencies, as currencies are always traded in pairs. The main or controlling currency is the first one listed in the pair. So, if the currency pair is written as JPY/USD, JPY means the Japanese Yen is said to be the controlling currency. A currency trader buys or sells a currency contract and earns profit or loss based on the fluctuations of the contract.
To understand currency futures, you must remember that currency futures have only one contract size; thus, you must also trade in multiples of that size. A Euro contract is always traded in size of $1,25,000. So, you must buy the contract at a multiple of that price size only.
The good news for currency futures is that they do not face issues of currency markets like forex brokers betting on their clients, decartelized price fixing, etc. However, the forex market is also more flexible and provides traders with a high level of leverage and customized position size.
Difference Between Currency Futures and Currency Market
- Underlying Asset:
- Currency Market (Forex): Direct trading of currencies in pairs (e.g., EUR/USD), focusing on exchange rates.
- Futures Market: Contracts derived from assets like commodities, indices, interest rates, or currencies.
- Market Structure:
- Currency Market: Decentralized, operates 24/5 across multiple financial institutions and brokers globally.
- Futures Market: Centralized, traded on regulated exchanges (e.g., CME, ICE), with specific opening and closing times.
- Leverage:
- Currency Market: This typically offers higher leverage (e.g., 50:1 or even 500:1, depending on the broker and region).
- Futures Market: This market offers lower leverage compared to forex (e.g., 10:1 or 20:1), with margin requirements set by the exchange.
- Trading Hours:
- Currency Market: Continuous 24-hour trading across global markets (Asia, Europe, and U.S. sessions) from Monday to Friday.
- Futures Market: Trading is limited to specific hours depending on the exchange and the asset, with some contracts offering extended or overnight trading.
- Contract Structure:
- Currency Market: Trades are spot transactions, meaning settlement usually occurs within two days (T+2), though positions can be rolled over.
- Futures Market: Contracts have set expiration dates, and settlement occurs either by physical delivery or cash settlement at contract expiry.
- Position Size:
- Currency Market: Traders can choose variable lot sizes (e.g., micro, mini, standard), providing flexibility in position sizing.
- Futures Market: Contract sizes are standardized (e.g., 1 contract of crude oil = 1,000 barrels), limiting customization of position sizes.
- Participants:
- Currency Market: Involves banks, central banks, financial institutions, hedge funds, and retail traders.
- Futures Market: Attracts speculators, hedgers, large institutions, and commercial entities managing price risk.
- Trading Costs:
- Currency Market: Typically involves spreads, varying depending on liquidity and volatility. Most forex brokers offer commission-free trading.
- Futures Market: Involves spreads and additional commissions, which brokers charge per contract traded.
- Expiration:
- Currency Market: There is no expiration; traders can hold positions indefinitely as long as they meet margin requirements and roll over positions (swap rates apply).
- Futures Market: Contracts have fixed expiration dates, requiring traders to close or roll over positions if they don’t want to take delivery.
- Regulation:
- Currency Market: Less centralized, with varying levels of regulation depending on the country and broker.
- Futures Market: Highly regulated by central exchanges and overseen by regulatory bodies (e.g., CFTC in the U.S.).
- Hedging:
- Currency Market: Mainly used by businesses and financial institutions to hedge currency exposure in international transactions.
- Futures Market: Widely used for hedging across various sectors, including commodities, interest rates, and currency fluctuations.
Currency futures markets move upward or downward in ticks, where every tick is defined for a specific currency rate for each trade and market. For example, in the Euro forex market, the tick size is 0.0005 dollars per euro. So, here the price move amounts – $1,25,000 X 0.0005= $6.25. If the price change for the day is $0051 for a euro, you would make $637.50.
In contrast, in the forex market, trades take place in multiplications of $1000. That gives traders tremendous flexibility in portion size. Ultimately, both markets attract different currency traders catering to their unique requirements.
Components of Currency Futures
Exchange rates of various currency pairs are the basis of currency futures. Forex futures are settled in cash with regard to the underlying currency pair. For example, a Euro futures market is based on Euro to Dollar, and the underlying currency remains the Euro.
The settlement and delivery here happen when the EUR/USD futures contracts end or expire. As a result, the buyer delivers $1,25,000 worth of euros in liquid cash to the seller on the contract’s expiration date. Also, it is important to note that currency day traders do not keep contracts until expiry, and thus, they do not have to deal with the settlement and do not receive the underlying currency in cash.
Day traders profit from the speculation about future currency futures and the difference between purchase and selling prices. Like average trading, you can also short-sell currency futures and earn from the price slumps.
Calculating the Profit of Currency Futures
To determine how much you have profited as a currency futures trader, focus on the expiration amount and tick value at entry and exit.
Let us simplify this for you.
Susan is a Euro forex trader and purchased a Euro forex contract at 2.3565, which she sold at 2.3585. She makes a profit of 20 ticks, where each tick size is $12.50. The profit would be $12.50*20 (which would be multiplied by the Euro FX contracts she has bought.)
To simplify things for you, we have mentioned ticking movements and the formula for calculating profit below.
Tick Movement= (Tick Value at the Time of Entry – Tick Value at the Time of Exit)
Profit= Number of Contracts Bought or Sold X (Tick Movement X Tick Value)
Every currency contract has a unique tick value; if you want to know more about it, you can visit the official websites of different exchanges, like the Chicago Mercantile Exchange.
The World of Margins
Margins play a prominent role in understanding currency futures. These margins are very different from those in stocks or other financial markets.
In other financial markets, the margin is associated with the leverage given to traders for trading in large quantities based on their portfolio values. However, in currency futures, margins refer to a trader depositing a certain amount as an initial margin before trading the contract. These margins defer to each broker, though the exchange sets the minimum margin requirements.
Brokers require a margin to offset losses. Thus, the margin is not a cost but a necessity. Once a trade ends or expires, the margin is available for traders and can be used again.
Which are the Popular Sets of Currency Futures?
Popular currency contracts offered by the largest currency futures exchange- the Chicago Mercantile Exchange, are as follows.
- EUR—The Euro to US Dollar currency future
- CHF—The Swiss Franc to US Dollar currency future
- CAD—The Canadian Dollar to US Dollar currency future
- RP—The Euro to British Pound currency future
- GBP—The British Pound to US Dollar currency future
- AUD—The Australian Dollar to US Dollar currency future
- RF—The Euro to Swiss Franc currency future
These are just the popular currency pairs; many combinations of currencies are traded on the futures market.
Futures Forex Trading
The forex market is the largest financial market in the world, with an average daily trading volume of U.S. dollars. There are numerous instruments to trade in this market, so much so that there is no bar on imagination. One such instrument is a derivative security named Forex Futures. It is noted that forex futures trading negotiates with a massive volume of 112 billion U.S. dollars in a day. This article will help you understand the world of forex futures and how to trade forex futures. So, let’s dive into it!
What are Forex Futures Contracts?
Like a standard futures contract, a forex futures contract is a standardized agreement between a buyer and seller to buy or sell a currency pair at a predetermined date, time, and size. This contract is widespread across various forex exchange markets. Unlike forex forwards, Forex futures contracts are publicly traded, which means that forex futures trading is regulated, non-customizable in size and settlement, and guaranteed for credit loss by a clearinghouse acting as an intermediary.
The clearinghouse here assures the process of maintaining and converting traders’ daily profit and loss into real cash by crediting or debiting their trading accounts with that amount daily. This process is also known as “Mark to Market.” This process considers the average of the last few trades to arrive at a settlement price for the day. This settlement price is then used to calculate the day’s profit or loss.
Forex Futures Trading Requires Margins
All the forex futures clearinghouses need a certain amount deposited by the traders as security, known as margin. When we talk about margin in the general sense, it is given to traders based on their portfolio value as a loan to trade higher volumes in the stock market, but that’s not the case with the forex futures market. If you want to trade, you must deposit the initial amount to meet the minimum margin requirement.
The margin indicates that both parties involved in the trade have the faith and intention to fulfill their contract formalities. There is no case of borrowing in forex futures trading. One of the key points about the margin in forex futures trading is that it requires a much lower amount compared to the stock market. It is even less than 10% for the forex futures market.
All forex futures traders must ensure they meet the minimum margin requirements. After daily mark-to-market procedures, traders must have a predefined amount in their account as the maintenance margin. If a supposed loss occurs and the margin amount goes down the maintenance margin, a margin call is given to the trader. The margin call asks the trader to deposit money into their trading account to return the margin amount to the required initial amount.
For example, Lisa is a forex futures trader. She has purchased a futures contract with an initial margin requirement of $5 and a maintenance margin of $4.50. Now, if her contact loses 1 dollar on a given date, her margin account would reach $4, which is lower than the maintenance margin requirement. So, she would receive a margin call to deposit the money to bring the margin value back to $5; she would have to deposit $1.
If her loss was any amount but not more than $0.49, she would not get a margin call as she would still have met the maintenance margin requirements, which are kept at $4.50. You can find more such examples of various types of contracts on the official website of the Chicago Mercantile Exchange.
Forex Futures Exchanges
Forex futures are a popular derivative instrument traded on all global exchanges. However, the most popular exchange award goes to the Chicago Mercantile Exchange (CME), as it records the daily highest volume of outstanding futures contracts. In 2013, the total number of contracts traded on CME was 3.16 billion. After CME, the second and third numbers came from the Intercontinental Exchange and Eurex, respectively, with the total contract numbering 2807.97 billion and 2190.55 billion in 2013.
Trading forex futures is not a challenge as it can be traded on an open out-cry system, such as through floor traders on an exchange or even by electronic mediums like a computer device and the Internet, just like online trading. With digitalization, the open out-cry system is being replaced with online trading. The beginning of this new era has already led to the phase-out of the out-cry system on the European exchanges.
The Tick and the Specifications of Contracts
Forex futures trading is standardized, so all the contracts are standardized by the exchanges. A few characteristics of forex futures trading set it apart from other contracts. For example, CAD/USD futures contracts are literally delivered physically to the buyer on the date of settlement. They are standardized at 1,00,000 Canadian dollars and traded for 20 months based on the quarterly cycle of March.
The minimum price fluctuations on a forex futures contract are known as the tick. It is unique to all the contracts; a trader has to be thoroughly familiar with this to trade in the future. For the contract CAD/USD, this tick size is $0.0001 for an increase in the Canadian dollar. Considering the contract standardization at 1,00,000, this increase translates to a $10 move. In layman’s language, if the Canadian Dollar rises from 0.75800 USD to 0.75850 USD, the buyer would win 5 ti,cks equal to $50 per contract.
Now, if a short seller takes a CHF/USD contract with the size of 1,25,000 Swiss Francs, here the tick size is $0.0001 for an increase in Swiss Franc, so if the price of the contract increases to 0.2250 from 0.2210, the short seller would lose $50 per contract.
The realm of forex futures markets is vibrant as it also does mini-contracts for traders wanting to trade in smaller minor acts. For mini-contracts, a trader gets the standardized contract size in half. There are also E-Minis contracts, in which the contract size is 1/10th of the actual contract size.
These features provide new traders or traders who cannot afford larger contracts with the opportunity to trade in the forex futures markets. These contracts have lower margin requirements and are traded 23 hours a day from Monday to Friday worldwide.
What are the Different Uses of Forex Futures?
There are primarily two types of usage for forex futures: (i) Hedging and (ii) Trading and Speculating.
Hedging
We will understand the concept of hedging through an example here.
There is an American company named ABC that does business in Europe. The company is expecting to receive a payment of €10,00,000 for all the services provided within five months. Now, let us assume the EUR/USD rate is at $1.04. The company fears that within the stipulated time frame, the price of the euro will fall, resulting in losses.
To prevent this, the company sells 8-euro futures contracts of €125,000 each. These contracts expire in 5 months at $1.06. So, now, when the euro slumps in 5 months, company ABC’s account will be credited with the appreciated dollar price.
At the end of the five months, the euro ranges at $1.03, which would have resulted in a loss if the company had not sold futures contracts. Buying euros at the spot rate (market rate) at the end of 5 months would have resulted in a loss of $10,000 for every €10,00,000.
But that’s not the case here. The company sold 8-euro contracts, and in the course of 5 months, it gained a profit of $3750 (the gain of 300 ticks considering that the minimum price move for each tick is $0.0001). The profit per contract amounts to $12.50. So, for 8 contracts in total, the ABC company has received a profit of $30,000, excluding fees and commissions.
Compensating the profit and loss, ABC made a profit of $30,000 in five months, whereas the loss stood at $10,000. So, ABC’s net profit, excluding any fees or commissions, would amount to $20,000, which obviously is a winning deal!
Trading and Speculating
The way a trader trades depends on their preferences, desires, and expectations. Techniques and the entry/exit time also affect trade. Long-term traders tend to hold positions for quite a long time compared to day traders, as their primary goals tend to defer. There are various types of traders in this regard, as stated below.
Day Trader:
A day trader is likely to hold a position overnight or can quickly enter/exit a position within minutes. Here, the focal point is the rate and volume fluctuations that can be tracked through technical analysis, such as chart patterns. The popular forex futures day trader technical tools are Bollinger Bands, Oscillators, Fibonacci Patterns, MACD, Moving Averages, Support, Resistance, etc. These tools are typical for equity trading and forex futures trading, making it easier for a trader to make transitions between the two asset types.
Swing Trader:
In contrast to a day trader, a swing trader stays in a trade overnight, and the holding position can even be extended to a month if needed. They also use technical analysis tools, but the time frame of technical Analysis differs as swing traders employ daily or weekly data in study along with macroeconomic aspects for the near future.
Position Trader:
The last type of traders are position traders, or we can call them fundamental traders because they hold a position for weeks or even years. Here, fundamental Analysis gauges more value than technical Analysis. Position traders are the least concerned with everyday profit and loss and look for the bigger picture. Compared to day traders and swing traders, they tend to have large stop loss and risk management procedures in place.
These stated characteristics are not hardbound but flexible, as in t, the end, it depends on what suits traders and their preferences. A day trader can also use fundamental analysis, such asen the Federal Open Market Committee data is about to be released. Just like that, a position trader can use technical Analysis to decide points for entry and exit. A swing trader can also hold a position for more than a month; it is subjective based on each individual.
Analytical Tools for Forex Futures Trading
Like the equities market, the forex market employs technical and fundamental Analysis. Technical Analysis uses price and volume data, whereas fundamental Analysis involves an in-depth study of a firm, ratio analysis, industry analysis, etc. For fundamental analysis of futures, a trader must be familiar with macroeconomic factors and forecasting principles.
A novice forex futures trader must understand several factors affecting a nation’s currency to learn how to trade in forex futures. These factors can be inflation or deflation rates, measures taken by the central banks, interest rate changes, business cycles, etc. A forex futures trader needs to learn economic indicators like yield curve, GDP, Consumer Price Index (CPI), data on employment or housing, etc. Though the list doesn’t end here, they also require studying various central banks’ reserve levels, current account deficits of nations, and how they would affect the currencies they are trading in.
Broder Prospects Affect the Forex Futures
Even geopolitical factors affect currency fluctuations. For example, the conflicts between Crimea and Russia or the U.S. and North Korea affect the currencies of these respective countries. Such conflicts impact the commodities of these nations, eventually hurting the currency rates.
For instance, energy commodities affect the price of Canadian and Australian dollars, so if a trader thinks that the conflicts between Crimea and Russia would decline oil prices, they would short-sell CAD futures or AUS futures to take advantage.
To understand the concept here, let’s take another example: We all know the economic crisis that Greece faced a few years ago, which affected the Euro rates. Now, hypothetically, a trader named Ken thought to take advantage of this turmoil. He took a bearish stance on EUR/USD and sold euro contracts in 2014 at $1.086 with the hope that they would go further down at the $1.07260 support level before the expiry.
He has a contract size of 1,25,000 euros; he expects to win at least 134 ticks,, resulting in him winning $1675. So, the turmoil of Greece here would result in a fortune for Ken.
Conclusion
No trading can be done without taking the risk, and the risk appetite varies for each trader. The essential element for traders in future trading in forex is to have sufficient knowledge and skills to perform and analyze technical and macroeconomic data. The need to understand various contracts based on diverse characteristics also can’t be ignored.
The liquidity, lower risk, lower margin, and regulated transparency make forex futures trading attractive. But traders also mustderstand that if a lower margin leads to high profits, it can alsd to a higher loss. In the end, trading is a responsibility you must fulfill with the most care and risk management in place.
The market for currency futures is regulated and dictates how each currency trader participates. The movements are described as ticks, and each tick fluctuates at a predefined value, which, in terms of ups and downs, states how much profit a trader makes.
The forex market is the largest financial market in the world, with an average daily trading volume of U.S. dollars. There are numerous instruments to trade in this market, so much so that there is no bar on imagination. One such instrument is a derivative security named Forex Futures. It is noted that forex futures trading negotiates with a massive volume of 112 billion U.S. dollars in a day. This article will help you understand the world of forex futures and how to trade forex futures. So, let’s dive into it!
He is an expert in financial niche, long-term trading, and weekly technical levels.
The primary field of Igor's research is the application of machine learning in algorithmic trading.
Education: Computer Engineering and Ph.D. in machine learning.
Igor regularly publishes trading-related videos on the Fxigor Youtube channel.
To contact Igor write on:
igor@forex.in.rs
