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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 it on a specific date in the future at a specific price. It is considered as derivative security. In currency futures, currencies can also be termed as an underlying asset, and are traded as contracts.
Currency futures are derivative security through which an underlying currency is hedged for another currency. For example, the Swiss Franc 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 the basics of it, 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).
It depends on currency traders’ requirements, skills, and knowledge to decide whether they want to dive into the currency market or currency futures. They require to understand what both markets are based on, how they work, how the margins work, and other matters related to them.
Understanding Currency Futures
As stated above, currency futures are dependent on the exchange rates of two currencies as currencies are always traded in pairs. The main or the 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.
For understanding currency futures, you have to keep in mind that currency futures have only one contract size; thus, you have to trade in multiple of that size as well. A Euro contract is always traded in size of $1,25,000. So, you have to buy the contract at multiple of that price size only.
Though, for currency futures, the good news is that currency futures do not face issues of currency markets like forex brokers betting on their clients, decartelized price fixing, etc. But it is also true that the forex market is more flexible and provides traders with a high level of leverage and customized position size.
Difference Between Currency Futures and Currency Market
Currency futures markets move upward or downward in ticks, where every tick is defined for a certain amount of 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 to that, in the forex market, trades take place in multiplications of $1000. That gives traders the flexibility of portion size till a great level. In the end, both markets attract different sets of currency traders catering to their unique requirements.
Components of Currency Futures
Exchange rates of various currency pairs are the base of currency futures. Forex futures are settled in cash with regards to the underlying pair of currency. For example, a Euro futures market is based on Euro to Dollar, and the underlying currency remains Euro.
The settlement and delivery here happen when the EUR/USD futures contracts end or expire, and as a result, the buyer delivers $1,25,000 worth euros in liquid cash to the seller. This delivery takes place on the expiration date of the contract. Also, it is important to note that currency day traders do not keep contracts till 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 currency futures speculation and the difference between purchase and selling prices. Just like normal 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, you have to focus on the expiration amount and tick value at the time of entry and exit.
Let us simplify this for you.
Susan is a Euro forex trader and purchases a Euro forex contract at 2.3565 which she sells 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 with the Euro FX contracts she has bought.)
To simplify it for you, we have mentioned what is a ticking movement 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 website of different exchanges like the Chicago Mercantile Exchange.
The World of Margins
For understanding currency futures, margins play a prominent role. Margins here are very different from the margins in the stock or the 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. But in currency futures, margins refer to the fact that a trader has to deposit a certain amount as initial margin before trading the contract. These margins defer to each broker though the minimum margin requirements are set by the exchange.
The margin is required by the brokers to offset losses if any. Thus, the margin is not a cost but a necessity. The margin is available for traders once the trade ends or expires and can be used again.
Which are the Popular Sets of Currency Futures?
Popular currency contracts offered by the largest currency futures exchange- Chicago Mercantile Exchange are as followed.
- 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; there are many combinations of currencies being 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 amounting to 6.6 trillion 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 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 would 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?
Just like a normal 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 popular across various forex exchange markets. Forex futures contracts are publicly traded unlike forex forward, which means that forex futures trading is regulated, non-customizable in terms of size and settlement, and guaranteed for credit loss by a clearinghouse that acts as an intermediary.
The clearinghouse here assures that the process of maintaining and converting daily profit and loss of traders 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 for calculating profit or loss for the day.
Forex Futures Trading Requires Margins
All the forex futures clearinghouses need a certain amount deposited by the traders as security, which is 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. Here, if you want to trade, you have to deposit the initial amount to meet the minimum margin requirement.
The margin indicates that both the 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 way less amount as margin compared to the stock market. It is even less than 10% for the forex futures market.
All the forex futures traders have to ensure that they meet the minimum margin requirements. After daily mark to market procedures, traders are required to have a predefined amount in their account as margin known as the maintenance margin. If a supposed loss occurs, and if the margin amount goes down the maintenance margin, a margin call is given to the trader. The margin call is to ask the trader to deposit money into his/her trading account to bring the margin amount back to the required initial amount.
For example, Lisa is a forex futures trader, and she has purchased a futures contract that has the initial margin requirement of $5, the maintenance margin is $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 up back to $5; she would have to deposit $1.
If her loss would be any amount but not more than $0.49, she would not get any margin call as she would still have met the maintenance margin requirements which is kept at $4.50. You can find more such examples on various types of contracts from the official website of the Chicago Mercantile Exchange.
Forex Futures Exchanges
Forex futures are a popular derivative instrument and are traded on all the exchanges across the globe, though, the award for the most popular exchange goes to Chicago Mercantile Exchange (CME) as it records the daily highest volume for outstanding futures contracts. In 2013, the total number of contracts traded on CME was at 3.16 billion. After CME, on the second and third numbers come 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 like through floor traders on an exchange or even by electronic mediums like a computer device and the internet just like online trading. With the digitalization, the open outcry 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, and as a result, all the contracts are standardized by the exchanges. There are a few characteristics of forex futures trading that sets 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 with the size of 1,00,000 Canadian dollars and are traded for a period of 20 months based around 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 language, if the Canadian Dollar rises from 0.75800 USD to 0.75850 USD, the buyer would win 5 ticks 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 includes mini-contracts for traders wanting to trade in smaller contract sizes. For mini-contracts, a trader gets the standardized contract size getting half. There are E-Minis contracts as well, in which the contract size is 1/10th of the actual contract size.
These features provide new traders or traders not being able to 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 and from Monday to Friday across the world.
What are the Different Uses of Forex Futures?
There are primarily two types of usage for forex futures: (i) Hedging (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 get a payment of €10,00,000 for all the services provided, within a period of 5 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 would fall, resulting in them getting losses.
To prevent this from occurring, the company sells 8-euro futures contacts of €125,000 each. These contracts would expire in 5 months at $1.06. So, now when the euro would slump in 5 months, company ABC’s account would be credited with the appreciated price of dollars.
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. As the company had sold 8-euro contracts, in the course of 5 months, the company 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 at $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 company had made a profit of $30,000 in five months, whereas the loss stood at $10,000. So, the net profit excluding any fees or commissions for ABC would amount at $20,000, which obviously is a winning deal!
Trading and Speculating
The way a trader trades depends on his/her preferences, desires, and expectations. In addition to that, 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 easily enter/exit a position within minutes. Here, the focal point is the rate and volume fluctuations that can be tracked through technical analysis like chart patterns. The popular technical tools for a forex futures day trader are Bollinger Bands, Oscillators, Fibonacci Patterns, MACD, Moving Averages, Support, and Resistance, etc. These tools are common for equity trading as well as for forex futures trading, which makes 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 into 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 as well 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. They tend to have large stop loss and risk management procedures in place compared to day traders and swing traders.
Though these stated characteristics are not hardbound, but flexible, as in the end, it depends on what suits traders and what are their preferences. A day trader can also use fundamental analysis like on the day when 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
Just like the equities market, the forex market also employs technical and fundamental analysis. Technical Analysis uses price data and volume data for analysis, whereas in fundamental analysis, the in-depth study of a firm, ratio analysis, industry analysis, etc. are taken into consideration. For fundamental analysis in the forex futures, a trader has to be familiar with macroeconomic factors and forecasting principles.
A novice forex futures trader has to understand several factors affecting a nation’s currency for learning 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. Along with that, 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, he/she also requires 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 the currency fluctuations, for example, the conflicts between Crimea and Russia or the U.S and North Korea affect the currency of these respective countries. The commodities of these nations get impacted by such conflicts which eventually hurt 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 lead to a decline in the oil prices, he/she would short sell CAD futures or AUS futures to take advantage.
Taking another example to understand the concept here: We all know the crisis that Greece faced economically a few years ago, and that affected the rates of the Euro. Now hypothetically, a trader named Ken thought to take advantage of this turmoil. He took a bearish stance of EUR/USD and sold euro contracts in 2014 at $1.086 with the hope that it 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 which would result 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 forex future trading is to have sufficient knowledge and skills to perform and analyze technical as well as macroeconomic data. The need to understand various contracts based on diverse characteristics can’t be ignored as well.
The liquidity, lower risk, lower margin, and regulated transparency make forex futures trading very attractive. But traders also require to understand that if a lower margin leads to high profits, it can also lead to a higher loss. In the end, trading is a responsibility that you have to fulfill with at most care and risk management in place.
The market of currency futures is regulated and dictates how each currency trader takes part in it. The movements are described as ticks, and each tick fluctuates in a predefined value. That in terms of up and down states how much profit a trader makes.
The forex market is the largest financial market in the world with an average daily trading volume amounting to 6.6 trillion 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 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 would 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
