How futures are applied in forex trading
Futures are agreements between two people to buy or sell an item at a specified price on an appointed date. In the financial world, futures are most commonly used to hedge against risk or speculate on the future direction of an asset.
For example, let’s say you are a wheat farmer and are worried about the possibility of wheat prices falling in the future. You could enter into a futures contract to sell your wheat at a set price in the future. This contract guarantees a minimum sale price for your wheat, even if the market price falls.
Alternatively, you might believe that wheat prices will rise, so you could enter into a futures contract to buy wheat at a set price at some point, giving you the potential to take advantageof rising wheat prices, as you can buy the wheat at a lower price than the future market price.
Traders use futures to bet on which direction an asset’s price will move. For example, if you believe the US dollar will rise against the Japanese yen, you could enter into a futures contract to buy dollars and sell yen. If the dollar does indeed rise against the yen, you will make a profit on your trade.
Futures contracts are traded on exchanges, and someone is always willing to take the opposite side of your trade, which means you can enter into a futures contract even if you don’t have the underlying asset.
For example, if you wanted to speculate on the future price of gold, you could enter into a futures contract to buy or sell gold without owning any gold. You could be betting on which direction the gold price will move.
Futures and the forex market
Futures contracts are used extensively in the forex market. All major currency pairs are traded as futures contracts on exchanges around the world.
This means that when you trade forex, you are essentially betting on which direction the exchange rate between two currencies will move. For example, if you think the US dollar will rise against the euro, you would buy dollars and sell euros in the form of a futures contract.
What is spot forex?
However, it is also possible to trade forex without using futures. This type of trading is known as spot forex, the most common way of trading forex.
When you trade spot forex, you buy or sell a currency pair at the current market price. There is no contract, and you can choose to close your trade at any time.
The main advantage of futures over spot forex is that futures contracts are standardised. This standardisation means there is no need to negotiate the terms of a contract, as all the details are predetermined.
In addition, futures contracts have an expiry date, while spot forex trades do not, which means that when you enter into a futures contract, you are committed to the trade until the contract expires.
The disadvantage of futures is that they are subject to margin calls, which means that if the value of your contract falls below a certain level, you may be required to deposit additional funds to maintain your position.
Spot forex trades do not have this risk, as you can close your trade anytime if the market moves against you.
Choosing between spot forex and futures will depend on your trading goals and preferences. Spot forex might be the better choice if you want the flexibility to close your trade anytime. However, if you want a more predictable and standardised way to trade, then futures might be the better option.
The bottom line
Futures contracts are a type of agreement that allows two parties to buy or sell an asset at a predetermined price and time. Futures are often used in the forex market to speculate which direction exchange rates will move. However, it is also possible to trade forex without using futures, known as spot forex. Choosing between spot forex and futures will depend on your trading goals and preferences.