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FOREX versus
Futures
The origins of today's futures market lies in the agriculture
markets of the 19th century. At that time, farmers began
selling contracts to deliver agricultural products at a later
date. This was done to anticipate market needs and stabilize
supply and demand during off seasons.
The current futures market includes much more than agricultural
products. It is a worldwide market for all sorts of commodities
including manufactured goods, agricultural products, and
financial instruments such as currencies and treasury bonds. A
futures contract states what price will be paid for a product
at a specified delivery date.
When the futures market is played by speculators, the actual
goods are not important and there is no expectation of
delivery. Rather, it is the futures contract itself that is
traded as the value of that contract changes daily according
the market value of the commodity.
In every futures contract there is a buyer and a seller. The
seller takes the short position and the buyer takes the long
position. The futures contract specifies a buying price, a
quantity and a delivery date. For example: A farmer agrees to
deliver 1000 bushels of wheat to a baker at a price of $5.00 a
bushel. If the daily price of wheat futures falls to $4.00 a
bushel, the farmer's account is credited with $1000 ($5.00 -
$4.00 X 1000 bushels) and the baker's account is debited by the
same amount. Futures accounts are settled every day.
At the end of the contract period, the contract is settled. If
the price of wheat futures is still at $4.00 the farmer will
have made $1000 on the futures contract and the baker will have
lost the same amount. However, the baker now buys wheat on the
open market at $4.00 a bushel - $1000 less than the original
contract, so the amount he lost on the futures contract is made
up by the cheaper cost of wheat. Similarly, the farmer must
sell his wheat on the open market for $4.00 a bushel, less than
what he anticipated when entering the futures contract, but the
profit generated by the futures contract makes up the
difference.
The baker, however, is still in effect buying the wheat at
$5.00 a bushel, and if he hadn't entered into a futures
contract he would have been able to buy wheat at $4.00 a
bushel. He protected himself against rising prices but he loses
if the market price drops.
Speculators hope to profit by the daily fluctuations in the
futures market by buying long (from the buyer) if they expect
prices to rise or by buying short (from the seller) if they
expect prices to fall.
FOREX
The foreign exchange market (FOREX) has several advantages over
the futures market. FOREX is a more liquid market – as the
largest financial market in the world it dwarfs the futures
market in daily exchanges. This means that stop orders can be
executed more easily and with less slippage in the FOREX.
The FOREX is open 24 hours a day, 5 days a week. Most futures
exchanges are open 7 hours a day. This makes FOREX more liquid
and allows FOREX traders to take advantage of trading
opportunities as they arise rather than waiting for the market
to open.
FOREX transactions are commission-free. Brokers earn money by
setting a spread – the difference between what a currency can
be bought at and what it can be sold at. In contrast, traders
must pay a commission or brokerage fee for each futures
transaction they enter into.
Because of the high volume of trading FOREX transactions are
almost instantly executed. This minimizes slippage and
increases price certainty. Brokers in the futures market often
quote prices reflecting the last trade – not necessarily the
price of your transaction.
The FOREX is less risky than the futures market because of
built-in safeguards in the trading system. Debits in futures
are always a possiblility because of market gap and
slippage.
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