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Forex Futures - An Introduction
By Priya of Cashsee.com

There are two general ways to trade Foreign Exchange, Spot and Forex Futures. While both involve the buying and selling of currency pairs, there are differences in how the trades are executed, and the framework for execution.

Spot has always been more accessible, but dealings with Forex Futures are now becoming more and more common. Thus, it is important for people who are learning about trading, along with active traders, to understand the distinction.

When most people talk about trading, they are generally referring to Spot Trading. The key to understanding what that means lies in the word "spot". That could be thought of as a derivation from the term "on the spot", which essentially means right here and now. So Spot Forex means that we are dealing with the rate of exchange for any given currency pair at this moment in time. So, if the rate of a particular Currency Pair, say the EUR/USD - which is probably the most popular pair - is at 1.45; then 100 Euros would fetch 145 Dollars.

Note that we have left out spreads from this example, for the sake of simplicity. Now, with Forex Futures, the idea is to add time to this equation. We do our trading based on the perceived value that a particular currency pair will have at some point in the future. So, let's use the EURUSD Currency pair in a hypothetical situation. As a Trader I might do some research and analysis, looking at the socio-economic environment, as well as charts.

Based on this research, I might be led to believe that, as some point in the future e.g. October 2009, the EURUSD pair will trade at 1.45. I could then agree to buy 145 Dollars at that point in time, based on the idea that it will cost me 100 Euros. This is what is called a Futures Contract. The idea here is that, regardless of what changes occur in the value of the currency pair, I will buy 145 Dollars in October 2009. The concept is not new. It's been around for centuries.

This system was brought into play as a way of reducing risk and essentially stabilizing prices in deals between buyers e.g. Merchants, and producers e.g. farmers. An example scenario is as follows. A Merchant places an order for 100 sheep at the market price. The farmer then agrees to deliver the sheep in 2 months time, as which point the merchant would pay. Shortly after the order is placed, the marketplace is flooded with sheep, for whatever reason. Suddenly, the farmer's sheep are no longer worth the original price, and the farmer loses money on the deal.

He loses money, even though the investment he put in the sheep was appropriate at the time of the deal. A similar situation could arise, this time to the detriment of the merchant. If, after the initial order is placed, large amounts of sheep are wiped out by some disease; the value of the sheep would suddenly increase. They would be worth more. The farmer could demand more money.

Enter, the Futures Contract. This agreement basically says that at the designated delivery time or day, this is the price that will be paid for the goods. This contract holds, regardless of the sudden sheep shortage, or overflow. It's a commitment that cannot be broken, in theory at least. Both parties have to look at the situation and look to the future, then make an informed decision. Then they must hope for the best. You can see the effects of the Futures concept a lot in today's society.

That's part of the reason why, even though Oil prices might drop suddenly today, it might take weeks for that to filter down to the pumps. The batch being sold was bought at the higher price, so they still sell it that way to consumers. Big Companies tend to do dealings in Futures to help mitigate risks. A similar concept is applied to Forex Futures.

Forex Futures, in practice, are not all that different from Spot Forex. Most people tend to close out their positions before the settlement date, as cash payments are calculated and settled on a daily basis. It is therefore possible to re-evaluate your position regularly to decide if you wish to remain in the contract.

So, they are not as final as it might seem.Typically, Futures are more difficult to get into because of some factors such as a larger account balance requirement. They are also traded at an Exchange, so trading is limited to the Session times of the exchange. However, they tend to offer lower spreads and transaction costs.


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