An Introduction To Trading Forex Futures

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An Introduction To Trading Forex Futures

The worldwide foreign exchange market has an average daily trading volume of more than $5 trillion US dollars, making it one of the world’s biggest marketplaces. Forexfutures are a developing type of derivative instruments in this market. This article will define and analyze these futures contracts, as well as their widespread uses, and will offer some analytical techniques required to properly negotiate a contract in the FX futures arena.

Key Takeaways

  • The worldwide foreign currency market has an average daily trading volume of more than $5 trillion US dollars.
  • Forex futures are standardized futures contracts that allow you to purchase or sell currency on a predetermined date, time, and contract size.
  • Futures contracts are openly traded, non-customizable (standardized in contract size and settlement methods), and credit losses are covered by an intermediary known as a clearinghouse.
  • Forex futures are traded on exchanges all around the globe, with the Chicago Mercantile Exchange (CME)Group being one of the most prominent.

What Are Forex Futures?

Forex futures are standardized futures contracts that allow you to purchase or sell currency on a predetermined date, time, and contract size. These contracts are exchanged on one of the world’s several futures markets. Futures contracts, unlike forwards contracts, are openly traded, non-customizable (standardized in contract size and settlement processes), and credit losses are covered by an intermediary known as a clearinghouse.

This assurance is provided by the clearinghouse via a mechanism in which daily profits and losses are transformed into real cash losses and refunded or debited to the account holder. This procedure, known as mark-to-market, calculates a settlement price by taking the average of the last few deals of the day. This settlement price is then used to evaluate whether a futures account has made a profit or a loss. Gains and losses are calculated depending on the latest settlement value between the previous day’s settlement and the current one.

Futures Margins

Futures clearinghouses need a margin deposit from participants. In the futures market, a margin is the initial amount of money placed to fulfill a minimum requirement, as opposed to a margin in the stock market, which is a loan from a broker to the customer based on the value of their present portfolio. There is no borrowing involved, and this first margin serves as a type of good faith to assure that both parties participating in a deal will meet their obligations. Furthermore, the initial margin requirement for futures is often smaller than the margin requirement for a stock market.

Should an account incur losses following daily mark-to-market, futures position holders must guarantee that their margin levels remain over a certain amount. referred to as the maintenance margin If the account balance falls below the maintenance margin requirement due to incurred losses, the trader will get a margin call and must deposit cash to bring the margin back up to the starting amount.

The Chicago Mercantile Exchange, or CME, provides an example of margin requirements for each kind of contract on their website here (more on the CME, below).

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The Exchanges

Forex futures are traded on exchanges worldwide. The Chicago Mercantile Exchange (CME)Group is one of the most prominent exchanges. Forex, like other futures contracts, may be traded in an open out-cry system with live traders on a pit floor or wholly electronically using a computer and Internet connectivity. In Europe, open-outcry trading has mostly been phased out and replaced with computerized trading.

As previously stated, the CME group leads the pack in terms of the sheer amount of derivatives contracts traded, with an average daily volume (ADV) of 19.1 million contracts in 2020. The CME Group and its intermediaries trade the vast majority of currency futures contracts.

Contracts Specifications and the Tick

Each futures contract has been standardized by the exchange and has unique qualities that set it apart from others. For example, the CAD/USD futures contract is physically delivered on the settlement day, is standardized in size to 100,000 Canadian dollars, and trades for a period of twenty months based on the March quarterly cycle (i.e., March, June, September, and December).

The minimal price fluctuation, often known as the tick, is of particular relevance to traders. A tick is unique to each contract, and the trader must grasp its qualities. The tick, or minimum price movement up or down, for the CAD/USD contract is $.0001 per Canadian dollar increment. With a regular contract of $100,000 Canadian dollars, this corresponds to a $10 move each way. That implies that if the Canadian currency rises from.78700 USD to.78750 USD, a short seller would lose 5 ticks, or $50 per contract.

Unlike the CAD/USD futures product, the CHF/USD contract has a contract size of 125,000 Swiss francs. In this scenario, the tick is $.0001 every Swiss franc increment, or $12.50 per contract.

Futures markets also include mini-contracts that are half the size of a typical contract and E-Minis that are one-tenth the size of their regular counterparts. Because of their enhanced liquidity and accessibility owing to reduced margin requirements, e-minis are suitable for beginning traders. Monday through Friday, the contracts trade 24 hours a day, around the globe.

Types of Uses: Hedging

Forex futures are widely utilized for both hedging and speculative purposes. Let’s look at an example of utilizing FX futures to reduce currency risk.

An American corporation doing business in Europe expects to be paid €1,000,000 for services delivered in five months. Assume, for the purpose of illustration, that the current spot EUR/USD rate is $1.04.

Fearing further deterioration in the euro’s value versus the dollar, the corporation may hedge the forthcoming payment by selling eight euro futures contracts, each holding €125,000 and expiring in five months at $1.06 per euro. The clearinghouse will credit the company’s account daily for the following five months as the euro falls more against the dollar.

After 300 ticks (with a minimum price change each tick of $.0001) and a multiplier of $12.50 per contract, the fund achieved profits of $3,750 per shorted contract. Before accounting for clearing costs and commissions, the business earns a total gain of $30,000 on the sale of eight contracts.

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If the American corporation in the example had not undertaken this transaction and instead got euros at the spot rate, they would have lost $10,000: $1.04 EUR/USD spot five months before futures expiration corresponds to a loss of $10,000 per €1,000,000.

Types of Uses: Trading and Speculating

As with the stock market, the varieties of trading methods are determined by the individual’s choices in terms of both strategies and time periods.

Day traders seldom maintain positions overnight and might be in and out of a transaction in a matter of minutes, hoping to capitalize on an intraday move. A day trader’s strategy revolves on price and volume activity, with a strong focus on technical analysis rather than fundamental issues. A forex futuresday trader typically utilizes the most common technical indicators seen in spot markets, such as Fibonacci patterns, Bollinger Bands, MACD, oscillators, moving averages, trend lines chart patterns, and support and resistance regions.

Many, if not all, parts of technical analysis for stocks can be applied to the futures market, making trading between the two asset classes a simple transfer for day traders.

Swing traders are investors who hold holdings overnight for up to a month. They often use longer-term technical analysis (hourly to daily charts) as well as short-term macroeconomic indicators.

Finally, there are position traders that maintain a position for many weeks to several years. For these people, macroeconomic issues may take precedence over technical analysis. Position traders are not concerned with day-to-day variations in contract prices, but rather with the big picture. As a result, they may use larger stop-losses and risk management methods than swing or day traders.

However, keep in mind that these are broad categories, and the distinguishing qualities of traders are not black and white. Day traders may use fundamental research at times, such as when Federal Open Market Committee data is issued.

Position traders, on the other hand, may use technical analysis tools to set up inputs, exits, and trailing stop losses. Furthermore, traders’ time frames are very subjective; a day trader may keep a position overnight, whilst a swing trader may hold a position for several months at a time. Trading styles, like those in the stock market, are wholly subjective and vary from person to person.

Types of Analytical Tools

FX futures traders, like stock market investors, use both technical and fundamental research. By definition, technical analysis studies price and volume data, and as a result, comparable approaches are used in both the equity and futures markets.

The main analytical difference between an FX trader and, say, a stock trader will be in how they use fundamental research. In the stock market, fundamental analysis may involve evaluating a company’s financial statements, management discussion and analysis, efficiency analysis, ratio analysis, and industry analysis. Depending on the analyst, overarching macroeconomic concepts may be overshadowed by company-specific peculiarities. However, FX futures traders (and FX traders in general) must be well versed with macroeconomic ideas and forecasting tools.

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The aspiring FX futures trader must comprehend the several variables that might influence a country’s currency, such as the causes and consequences of inflation/deflation, as well as the remedies available to a country’s central bank and interest rate differentials. The trader must comprehend the primary drivers of a country’s business cycles and be able to interpret economic indicators such as (but not limited to) yield curves, GDP, CPI, housing, employment, and consumer confidence statistics.

Furthermore, the trader must be able to analyze macroeconomic accounting principles such as a central bank’s level of reserves, current/capital account surpluses and deficits, as well as study the causes and outcomes of speculative currency attacks, for example, the Bank of England’s Mexican and Thai currency debacles make for interesting case studies.

Finally, the trader must understand the impact of geopolitical turbulence on a country’s currency, like as the crisis in Crimea and the accompanying sanctions imposed against Russia, as well as the impact of commodities prices on what is known as commodity dollars.

For example, both the Canadian and Australian dollars are vulnerable to changes in commodity prices, particularly those related to energy. If a trader believes that oil will continue to fall, they may short CAD futures or place a long bet in the hopes of an oil comeback. Fundamental analysis for FX futures, once again, is concerned with a bigger picture of the globe and the overall relationship of the markets.

A Brief Example

Let us suppose that, after reviewing the technicals and the volatility surrounding Greece’s future in the eurozone, a trader chooses to short the euro June 2015 contract. They are short the June contract at $1.086, believing that the euro would fall to near-term support (around $1.07260) before expiry.

Image by Sabrina Jiang © Investopedia2021

If their transaction is successful, they stand to earn 134 ticks, or $1,675, with a contract amount of 125,000 euros ((1.0860 – 1.07260) x 125000). Their initial margin would be $3,410 at a maintenance margin requirement of $3,100 USD x 1.10 (CME regulations mandate 110% of the maintenance margin requirement for speculative transactions). Taking their $1,675 profit and dividing it by their $3,410 margin yields a leveraged return of 49%.

The Bottom Line

Trading FX futures, like any other speculative activity, is dangerous. The trader must have a basic understanding of technical and macroeconomic analysis, as well as the specific features and exchange-related laws of each contract. Forex futures are appealing trading vehicles because to their transparency, liquidity, and minimal chance of default. However, before entering their first transaction, the trader must understand the potential of the margin in magnifying losses (as well as winnings), do appropriate due research, and have a sufficient risk management strategy in place.

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