FXCM Insights

Forex Futures

Forex futures are derivatives contracts that help investors manage the risk associated with currency fluctuations. Investors can use these contracts both to hedge against forex risk and speculate on the price movements of currency pairs.

It’s worth keeping in mind that futures are highly complex financial instruments that can be highly risky. As a result, knowing how these contracts work—in addition to their associated risks—is crucial to using them effectively.

Futures Basics

Futures are financial contracts that obligate two parties to make a specific exchange for a set value for a predetermined time. Contracts of this type provide information on the underlying asset being exchanged in addition to the amount, price and time.

Termination Dates

Every futures contract that is created has a termination date. This is the point at which the underlying assets exchange hands, unless a trader establishes an opposite position that offsets the original contract. Should a trader set up two contracts that act in this manner, their position is neutral.

Standardised Contracts

While some derivatives can be customised, futures are standardised, meaning they have specific contract sizes and set procedures for settlement. While many of these contracts are quoted against the U.S. dollar, some are quoted against other currencies, such as the British pound or Swiss franc.

Exchange-Traded

Futures contracts are traded on exchanges like the Chicago Mercantile Exchange (CME) and Intercontinental Exchange. Clearing houses process these transactions, which helps protect contract participants against counterparty risk.

In many cases, traders who are interested in trading through exchanges will need to go through the brokers that work with these marketplaces.

Leverage

Futures make significant use of leverage, a feature that can amplify both the gains and losses of traders.

Entering a futures contract requires a trader to deposit margin, which in this case is money that a participant is willing to put down as a sign of good faith. However, this margin could be a mere fraction of the total value of the contract that a trader enters.

For example, an investor might be able to enter into a €125,000 contract with €12,500 in margin. Once the investor has entered a forex futures contract like this, a small change in the price of the underlying asset could yield big results.

While a modest increase in the price of this asset could generate significant gains for the trader, an equally small decline may produce substantial losses. Also, a futures trader could end up owing more money than the initial margin they supplied.

As a result of these risks, traders who are thinking about trading forex futures can benefit from doing extensive research before entering any positions.

Futures Pricing

Futures contracts are quoted in many different currencies. While often quoted in the U.S. dollar, they can be quoted in other currencies, for example the British pound and the Swiss franc.1)Retrieved 17 July 2017 https://www.thebalance.com/currency-futures-1031167 Every contract has a minimum amount it can move, which is referred to as a “tick.”

For example, the EUR/GBP contract has a tick of £0.00005 GBP per EUR.2)Retrieved 17 July 2017 http://www.cmegroup.com/trading/fx/g10/euro-fx-british-pound_contract_specifications.html Because the contract is worth €125,000, the minimum price movement of this future is £6.25.

If EUR/GBP falls from 0.79000 to 0.78900, a trader who had used a futures contract to take a long position on this pair would have lost 20 ticks, or £125.00 per contract. However, an investor who had taken a short position would have gained the same amount.

Hedging

Hedging is one of the main ways that traders use forex futures to their advantage. By using this strategy, they are reducing their exposure to the risk created by currency fluctuations.

For example, if a trader owns stocks that are based in different countries—and whose revenue and earnings are sensitive to changing foreign exchange rates—they may harness forex futures to help protect against the downside risk these stocks could face should certain currencies decline in value.

Speculation

Speculation is one area where a forex trader can potentially generate some compelling returns. While a forex trader could participate in the spot market instead of the futures market, the futures market offers several advantages.

For starters, traders can enjoy lower transaction costs when taking part in the futures market instead of the spot market. They can also access greater leverage. Additionally, the futures market can offer them lower spreads than the spot market.

However, traders may need a far larger initial capital outlay to take part in the futures market.

Further, investors looking to trade forex futures will need to do so during the trading hours of the relevant exchanges.

Trading Strategy

Forex traders can use many of the same strategies in futures markets that they would use when trading in the spot markets.

For example, these traders could harness fundamental analysis to review key information such as macroeconomic data in an effort to get a better sense of what different currencies should be worth.

Technical analysts, however, may analyse a wide range of indicators—such as moving averages and Fibonacci patterns—in order to determine the best times to enter and exit positions.

Summary

Forex futures are contracts that help users manage risk. They can be used both to hedge and to speculate. While they provide many distinct benefits when compared to the spot market—for example greater leverage and lower transaction fees—they also have their own unique risks.

Because futures are complex financial instruments that rely on leverage, traders can benefit from doing significant research before using them. In addition, traders may want to speak with a qualified professional before harnessing these contracts.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

Leverage is a double-edged sword and can dramatically amplify your profits. It can also just as dramatically amplify your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.

Any results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Simulated or hypothetical trading programs are generally designed with the benefit of hindsight, do not involve financial risk, and possess other factors which can adversely affect actual trading results.

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