A Guide To Forex Futures
What Are 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.
Basics Of Forex Futures
Futures contracts are financial derivatives products 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. In order to become competent in futures trading, it's imperative that one is aware of the underlying asset's fundamentals, pricing tendencies, applied leverage and the contract expiration date.
Currency futures or FX futures are standardised contracts that obligate the holder to buy or sell a specific quantity of a currency on a forthcoming date in time. The underlying asset is priced using the currency exchange rate itself, much like in conventional forex trading. However, currency futures are exchange-traded issues, contrary to the over-the-counter (OTC) forex market.
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.
FX futures contracts are available on exchanges around the world in many different forms. Among the most popular products are listed on the Chicago Mercantile Exchange (CME) and are priced against the USD. To illustrate an FX futures contract's form and function, let's review the CME's standardised specifications for the Euro FX:
- Quantity: 125,000 Euro
- Exchange: EUR/USD
- Pricing: U.S. dollars and cents per Euro increment
- Minimum Tick Size: 0.00005
- ** Tick Value**: US$6.25 per tick
- Contract Months: Listed quarterly, March, June, September, December. Contracts are listed for 20 consecutive quarters
- Expiration: Trading terminates two days prior the third Wednesday of the contract month
- ** Settlement**: Deliverable
As the specifications above indicate, currency futures are highly standardized financial derivatives. The terms of trade are clearly spelled out, from the applied leverage and expiration dates to settlement procedures. Thus, trading the EUR/USD on the forex market is far different from trading the Euro FX on a futures exchange.
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.
Referring to the specifications above for the CME Euro FX, trade is terminated two days before the third Wednesday of the contract month. At that point, the contract is taken "off the board" and ceases to be tradable. Subsequently, the contract's public liquidity goes to zero as the exchange and clearing house initiate settlement procedures.
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.
As mentioned, futures contracts are traded on exchanges like the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE). 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.
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. Although futures margins vary according to exchange, product, broker and market conditions, they are typically greater than conventional forex margins.
For example, the CME Australian dollar FX (AUD/USD) has a contract size of 100,000 AUD and may be traded on an intraday basis for around 1,500 AUD per contract. This is a margin rate of 1.5%, well in excess of forex dealers that offer up to 400/1 leverage or an AUD/USD margin of 0.25%.
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. Should initial margin requirements be violated, the trader may receive a margin call or have open positions prematurely liquidated.
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 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. 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. 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.
How Do You Use Forex Futures?
In the live market, there are two reasons to engage FX futures: hedging and speculation. For active traders, each is an important pursuit that can directly impact profitability.
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.
In addition, investors often look to currency futures as a means of managing interest rate risk. During the COVID-19 pandemic of 2020, market participants frantically searched for viable hedges against dovish monetary policy and broader economic risk. Subsequently, FX futures contracts from the Canadian dollar to the Japanese yen became popular and traded with enhanced volumes and pricing volatility.
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. In some cases, they are also able to 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. Also, investors looking to trade forex futures will need to do so during the trading hours of the relevant exchanges.
What Are Forex Futures Trading Strategies?
Forex traders can use a great deal of their conventional forex training in the 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. When compared to other assets such as stocks or exchange traded funds (ETF), the fundamental forex to FX futures transition is fairly smooth.
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.
Tools For Currency Futures Trading
As mentioned, there are two types of tools that may be employed in currency futures trading: fundamental and technical. Each variety is important to the trade of FX futures and plays an integral role in countless trading strategies.
The world's currency markets have a set of underpinnings all their own. From economic performance to politics, there are many important factors of which to be aware. Below are a two of the largest:
- Economic Data: Official reports such as GDP, CPI, PPI and labour statistics can all instantly sway exchange rate valuations.
- Monetary Policy: Changes to monetary policy made by a nation's central bank is one of the largest drivers of volatility on the forex market and in currency futures. Statements or actions from the U.S. Federal Reserve (FED), Bank of England (BoE) or Bank of Japan (BoJ) are examples of key monetary policy-oriented events.
It's important to remember that the currency markets are truly global in nature. For instance, if one is trading the EUR/USD, then being aware of the day's happenings in the U.K. and U.S. is imperative to successful trade. Perhaps the most valuable fundamental currency futures trading tool is a detailed 24-hour economic calendar.
From a technical standpoint, FX futures are traded in a variety of ways. Trend, reversal, range or momentum strategies may all be successfully executed within the context of a comprehensive plan. To do so, the following technical tools are frequently utilised:
- Oscillators: Momentum oscillators are one way in which technical traders identify overbought and oversold markets. Examples of these tools are the Stochastic and moving average convergence divergence (MACD) indicators.
- Support & Resistance Levels: Support & resistance levels are any specific price point that may influence the future path of price action. Examples include pivot points, Fibonacci retracements and moving averages.
One of the greatest benefits of technical tools is that they are quantitative in nature. No matter what the market state may be, technicals reflect evolving price action. In doing so, technical FX futures trading tools promote informed decision making, strong strategy development and consistent trade.
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.
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.
FXCM Research Team
FXCM Research Team consists of a number of FXCM's Market and Product Specialists.
Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.
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