Trading Forex Vs Futures: Key Differences
Financial markets and the terminologies you come across within them may be confusing sometimes. A lot of terms are only differentiated on highly technical grounds, and it is understandable why you may be confused about the difference between a couple of them.
Forex and futures trading, although may be accurately used in the same context or sentence, are one of these terminologies. Both cover a wide scope but are still limited and get entangled in some areas.
So you don’t make mistakes while coming up with an investment strategy, our article clears the air around both forex and futures with information on how to trade Forex, where these terms differ and the points they converge at. Let’s get right in.
Forex is an acronym for Foreign Exchange, which is simply the conversion of one currency to another at an exchange rate. The forex market is an electronic medium where large corporations, banks, and individual investors like you may purchase or sell one foreign currency for another currency.
You get into the market using a brokerage account and use it for a whole lot of reasons, including foreign commercial activities, personal activities like traveling, and more importantly to us, trading.
Forex trading is where you convert currencies with the sole objective of making profits. Ordinarily, you purchase one currency hoping that its value increases, and sell it off for another currency in the future. There is more to this, however.
When trading forex, currencies are typically grouped in pairs. The price of a currency pair is the exchange rate between the initial currency quoted against the second. One example is the USD/JPY pair worth 143 today, which signifies that 1 USD ($) is exchanged for 143 JPY (¥).
How Does Forex Trading Operate?
When you buy a pair, what happens is that you sell the second (quote) currency and purchase the first (base) currency. From our example, you sell JPY for USD and (due to the paired currency) may only sell your new USD in exchange for JPY. In the ordinary sense, you profit when the base currency (USD) grows against the quote currency (JPY). This means when you sell the pair with profit, you sell USD and buy JPY with less value than before.
Now, there are three Forex trading types, each determining the options available for you to make your profit. These are spot, futures, and forwards trading.
Spot trading is where you instantly buy and sell assets (currency pairs) at their immediate market price, and this is how to trade Forex ordinarily. It is this spot market that the futures and forwards trading markets rely on.
Futures is a form of trading that involves purchasing and selling an asset at a fixed price, with the delivery of the asset concluded at a later date. This fixed price is usually the current price in the spot market, and the later date is also limited and agreed upon in a contract between the buyer and the seller. You also need a down payment or “margin” to maintain the contract.
This type of trading is not limited to only the Forex market but is inherent in CFD trading markets, indices trading, commodity markets, and cryptocurrency trading, amongst a barrage of others. The main use of futures in all these markets, however, is to hedge against the risks of price changes or volatility.
The buyer and seller agree on a fixed price, and the exchange transaction goes through at a future date based on that exact price. This is regardless of whether the market price has risen or fallen. Forwards trading is the same as this, but while futures trading is facilitated through regulated exchanges, forward trading is done over the counter (OTC).
Typically, delivery of the product is completed on the future date agreed on. However, with futures trading today, instead of getting the asset, the buyer gets the value of the asset in its current market price. This could be beneficial for either the buyer or seller, and this is where speculation trading for profit comes in. We will present an example using the Forex market.
How Futures Trading Coincides With Forex Trading
We have seen that futures trading is one of the trading methods within Forex, but it is not limited to the Forex market. This is the major difference between them. They also coincide on so many grounds. How do you trade futures with Forex?
Using our example, when you buy the USD/JPY currency pair on a futures contract, you go into an agreement with your broker to complete the exchange transaction at a later date. You leave a down payment or deposit called a “margin,” which is worth the current value of the currency pair in the spot market. Let’s assume the current market value is 143.
When this future date arrives, you buy the currency pair at this exact price. If the market price has increased to 200, you have made a loss, as you get less USD than if you bought at 143. In the same vein, if the price is reduced to 100, then you make a profit, as you receive more USD.
As said earlier, futures trading today doesn’t require delivery of the asset; you get the cash value instead. This means you get the equivalent of the USD value in the currency you used in opening the trade. One other thing to note is that, while regular spot Forex trades run infinitely, futures trades typically have an expiry date.
|Exists as an entire market on its own||Is a trading method used within commercial and investment markets, including Forex|
|May be executed through over-the-counter transactions||Only executed on regulated exchanges|
|Spot Forex is always determined by current market value||Futures allows for customized pricing agreements between buyer and seller|
|Perpetual transactions with no expiry dates||Contracts always have an expiry date for delivery of asset or value of it|
|Doesn’t require margin or down deposit as the exchange of cash and asset is immediate||Contracts require a margin to be maintained|
From all said, the key differences between Forex and futures are that futures are only a trading method within the Forex market that helps to protect the transacting parties against price changes. Unlike other types of Forex transactions, futures also have an expiry date, require a margin to be maintained, and may be valued separately from the market price.