Currency Trading Basics: Background to the Forex Market
Before jumping into an explanation of understanding Forex futures it is a good idea to have a basic grasp of the Forex market, how it works and why it is different to other investment markets. The majority of investment markets are about trading physical commodities, however, that is where the difference occurs as the Forex market is all about trading currencies. Forex futures have an important role to play, but you need to understand the big picture first.
The Forex market is the biggest liquid market in the world, with trillions of dollars traded each day. This is a market where all the transactions are conducted online, and is open 24 hours a day 5 days a week. Until a few years ago participation was limited to large financial institutions and major banking corporations, but that all changed with the rapid uptake of the Internet and associated technology. These days the market is wide open to all traders worldwide, whether they have thousands to invest or even just a few hundred dollars. Forex trading can be done on a full time basis or just as a means to earn a bit of extra income in your spare hours.
A unique aspect of the Forex market is that there is no centralised marketplace for the foreign exchange. Everything is done by means of online transactions through online brokers.
What is Futures Trading?
Futures are known as exchange-traded derivatives and actual currencies are not traded in the futures market. Futures markets trade in contracts that represent a claim to a particular currency purchase. The purchase is one where, the value of the currency is already predetermined and a prescribed date for settlement has been agreed.
In the United States, the futures market is regulated by the National Futures Association. Each of the futures contracts will contain specific details of the agreement, such as the amount of units being traded, the delivery and the settlement dates, plus the minimum price increments that are not allowed to be customised. The foreign currency exchange provides clearance and settlement.
The contract is usually settled in cash for the exchange at the end of the term of the contract. The futures market serves as a protection against risk in currency trading. Futures tend to have lower transaction costs than similar debt instruments. Buyers and sellers of futures contracts are easily found which results in a high liquidity in the market.
Currency Futures Trading Contracts
Forex futures contracts are a standardised contract, with specifications as set by the futures exchange. The only part that is negotiable by the buyers and sellers is the exchange rate. All other items such as the intrinsic currency, the trading unit and month of delivery are established by the futures exchange.
Forex futures risks
All Forex futures trading or currency futures are fraught with a certain element of risk, since this is a well known high risk area. However, for many traders that is the attraction to the trade, and the fact that massive fortunes can be acquired in a very short time frame. This makes many traders consider the risk well worth their time. The more experienced trader will make sure he has well thought out risk management strategies in place to fall back on should the trade be going against him.
Forex futures trading vs. traditional futures trading
Forex futures and traditional futures principally operate in the same basic way; the trader purchases a contract to buy or sell specific amounts of an asset at a certain price on an already determined date. The key difference however, is that the Forex futures unlike traditional futures, are not traded on a central exchange, they can be moved through several exchanges anywhere in the world.
But no matter where they are traded Forex futures are bound to a contract which has a designated size and in whole numbers. One point to remember is that, unlike the spot Forex market, currency futures quotes are all made against the US dollar.