Perhaps the oldest standardized mode of trade involves the swapping of foreign currencies. Exchanging one form of money for another has long been an unavoidable aspect of travel, as well as a speculative endeavor. Whether you’re a professional arbitrager or simply striking out abroad, the currency trade is an indispensable component of international commerce.
In the arena of active trading, currencies are engaged via the futures or forex marketplaces. Each venue furnishes participants with unique offerings and specific advantages to using its infrastructure. Here we break down the differences of futures vs. forex currency trading.
The term “forex” is an abbreviation for “foreign exchange marketplace.” An exclusively digital over-the-counter (OTC) venue, the forex facilitates the trade of currencies throughout the world. In terms of size, it’s the world’s largest market. According to the Bank for International Settlements’ (BIS), daily turnover on the forex averaged a staggering US$5.1 trillion for 2016.
Forex trading is conducted by “pairing” one currency with another in order to create a tangible exchange rate for reference. In practice, one currency is bought while another is simultaneously sold on the open market. In this fashion, the relative value of the pair is able to be traded in a standardized manner.
The forex is dominated by the eight prominent global currencies and their pairings, known as the “majors.” The majors represent more than 60 percent of daily turnover, making them the most liquid and suitable products for short-term traders.
|USD/JPY||U.S. Dollar/Japanese Yen||Gopher|
|GBP/USD||British Pound/U.S. Dollar||Cable|
|USD/CAD||U.S. Dollar/Canadian Dollar||Loonie|
|USD/CHF||U.S. Dollar/Swiss Franc||Swissie|
|AUD/USD||Australian Dollar/U.S. Dollar||Aussie|
|NZD/USD||New Zealand Dollar/U.S. Dollar||Kiwi|
As the world’s reserve currency, it stands to reason that the U.S. dollar plays a role in the eight major pairings. In fact, it is involved in more than 90 percent of all traded forex volume. Two other classifications of currency pairs listed on the forex are known as “minors” and “exotics.” Here are a few of the most commonly traded minor and exotic pairs:
|GBP/JPY||British Pound/Japanese Yen|
|GBP/CHF||British Pound/Swiss Franc|
|CHF/JPY||Swiss Franc/Japanese Yen|
|NZD/JPY||New Zealand Dollar/Japanese Yen|
|USD/SEK||U.S. Dollar/Swedish Krona|
|USD/ZAR||U.S. Dollar/South African Rand|
|USD/HKD||U.S. Dollar/Hong Kong Dollar|
A majority of the minors and exotics are marked by wide bid/ask spreads and limited liquidity. As a result, many active traders steer clear of the minors and exotics altogether.
Currency futures, or FX futures, are another way individuals can trade their opinions regarding the economic prowess of nations around the globe. FX futures are a representation of what a foreign currency will be worth in U.S. dollars at a specific point in time. In contrast to the forex, FX futures are priced in U.S. dollars per unit of the foreign currency in question and have a defined expiration date.
The Chicago Mercantile Exchange (CME) has a collection of FX futures contracts available for trade including the majors, emerging markets, and crosses.
|New Zealand Dollar||6N|
A group of emerging market currency contracts — such as the Mexican peso (6M), Brazilian Real (6L) and Russian Ruble (6R) — are denominated in U.S. dollars and available for trade under sparse liquidity.
In addition, the CME offers several cross rates facing a broad spectrum of currencies, with pricing independent of the U.S. dollar. However, liquidity is limited because trading volumes are relatively small.
What Will It Be: Futures vs. Forex
Both the futures and forex markets are licensed and regulated by jurisdictional financial authorities. Given the selection of an accredited brokerage service, a trader can be confident that deposited funds are secure.
Depending on the trader’s resources and objectives, one market may be preferable to the other. Here are a several facets of each market that you should consider:
- Pros: Highly liquid, variety of instruments, no expiration, no daily market close
- Cons: Interest costs (rollover), lack of transparency, variable spread pricing
- Pros: All-in upfront pricing, no carry costs, ideal for hedging
- Cons: Overnight margins, contract expiration
Each marketplace offers several unique advantages and disadvantages to active traders. For guidance on which venue may be best suited for your resources and needs, check out Daniels Trading’s currency futures overview and related webinars.