Introduction: Forex Markets and Futures

Forex Markets and Futures

Trading spot forex is also different from trading futures, and like equity traders, many futures traders have also added currency spot trading into their portfolios. We know that the spot forex market has the following attributes:

Characteristics of FX Markets

  1. It is the largest market in the world with growing liquidity.
  2. The market is open 24 hours, 5.5 days a week for trading.
  3. Profits can be made in both bull and bear markets.
  4. There are no trading curbs and short selling is permitted without an uptick.
  5. Instant executable trading platform minimizes slippage and errors.
  6. Leverage can be extremely high, which can magnify profits as well as losses.

Characteristics of Futures Markets

  1. There is limited market liquidity depending on the month of contract trades.
  2. The presence of exchange fees results in more costs and commissions.
  3. Market hours for futures trading are much shorter than spot and are dependent on the product traded; each product may have different open and closing hours, and there is limited after-hours trading.
  4. Futures leverage is higher than equities, but still only a fraction of the leverage offered in FX.
  5. There tends to be prolonged bear markets.
  6. Pit trading structure increases error and slippage.

Like in the equities market, traders can implement the same strategies they use in analyzing the futures markets in the FX market. Most future traders are technical traders, and the FX market is perfect for technical analysis.

In fact, it is the most popular analysis technique used by professional FX traders. Taking a closer look at how the futures market stacks up, we see the following.

Comparing Market Hours and Liquidity

The volume traded in the FX market is estimated to be over five times that of the futures market. The FX market is open for trading 24 hours a day, but the futures market has confusing market hours which vary based on the product traded.

For example, if you traded gold futures, it is only open for trading between 7:20 am and 1:30 pm on the COMEX. If you traded crude oil futures on the New York Mercantile Exchange, trading would only be open between 8:30 am. and 2:10 pm.

These varying hours not only create confusion but also makes it difficult to act on breakthrough announcements throughout the remainder of the day.

In addition, if you have a day job and can only trade after hours, futures would be a very inconvenient market product to trade.

You would basically be placing orders based on past prices that are not current market prices. This lack of transparency makes trading very cumbersome.

In addition, each time zone has its own unique news and developments that could move specific currency pairs, and with futures it can be difficult to act on breaking overnight news.

Low to Zero Transaction Costs

In the equity market, traders must pay a spread and/or a commission. With future brokers, average commissions can run close to $160 per trade on positions of $100,000 or greater.

The OTC structure of the FX market eliminates exchange and clearing fees, which can in turn lowers transaction costs.

Costs are further reduced by the efficiencies created by a purely electronic market place that allows clients to deal directly with the market maker, eliminating both ticket costs and middlemen.

Because the currency market offers round-the-clock liquidity, traders receive tight, competitive spreads day and night. Futures traders are more vulnerable to liquidity risk and typically receive wider dealing spreads, especially during after-hours trading.

Low to zero transaction costs make online FX trading the best market to trade for short-term traders. If you are an active futures trader who typically places 20 trades a day, at $100 commission per trade, you would have to pay $2,000 in daily transaction costs.

A typical futures trade involves a broker, a future commissions merchant (FCM) order desk, a clerk on the exchange floor, a runner, and a pit trader. All of these parties need to be paid, and their payment comes in the form of commission and clearing fees, whereas the electronic nature of the market minimizes these costs.

No Limit Up or Down Rules/Profit in Both Bull and Bear Markets

Unlike the tight restriction on the futures market, there is no limit down or limit up rule in the FX market.

For example, on the S&P index futures, if the contract value falls more than 5% from the previous day’s close, limit down rules will come in effect, whereby on a 5% move, the index would only be allowed to trade at or above this level for the next 10 minutes.

For a 20% decline, trading would be completely halted. Due to the decentralized nature of the FX market, there are no exchange-enforced restrictions on daily activity, which can help eliminate missed opportunities caused by archaic exchange regulations.

Execution Quality and Speed/Low Error Rates

The futures market is also known for inconsistent execution, both in terms of pricing and execution time.

Every futures trader has, at some point in time, experienced a half hour or so wait for a market order to be filled, only to find that the order has been executed at a price far away from where the market was trading when the initial order was placed. Even with electronic trading and limited guarantees of execution speed, the price for fills on market orders is far from certain.

The reason for this inefficiency is the number of steps that are involved in placing a futures trade. A futures trade is typically a seven-step process:

  1. The client calls his broker and places his trade (or places it online).
  2. The trading desk receives the order, processes it, and routes it to the FCM order desk on the exchange floor.
  3. The FCM order desk passes the order to the order clerk.
  4. The order clerk hands the order to a runner or signals it to the pit.
  5. The trading clerk goes to the pit to execute the trade.
  6. The trade confirmation goes to the runner or is signaled to the order clerk and processed by the FCM order desk.
  7. The broker receives the trade confirmation and passes it on to the client.

An FX trade in comparison is typically only a three-step process. A trader would place an order on the platform, the FX dealing desk would automatically execute it electronically, and the order confirmation would be posted or logged on the trader’s trading station.

The elimination of the involvement of these additional parties increases the speed of the trade execution and decreases errors.

In addition, the futures market typically operates under a ‘‘next best order’’ system, under which your trades frequently do not get executed at the initial market order price, but rather, at the next best price available.

For example, let’s say a client is long 5 March Dow Jones futures contracts at 8800. If the client enters a stop order at 8700, when the rate reaches this level, the client will most likely be executed at 8690. This 10-point difference would be attributed to slippage, which is very common in the futures market.

On most FX trading stations, traders execute directly off of real-time streaming prices.

Barring any unforeseen circumstances, there is generally no discrepancy between the displayed price and the execution price. This holds true even during volatile times and fast-moving markets.

In the futures market, execution is uncertain because all orders must be done on the exchange. This creates a situation where liquidity is limited by the number of participants, which, in turn, limits quantities that can be traded at a given price.

Real-time streaming prices ensure that market orders, stops, and limits are executed with minimal slippage and no partial fills.

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