today. Large institutional investors and hedge funds are big players in the
forex market; and in the past three years, the Foreign Exchange market had
an estimated 50 percent increase in volume. Some had credited this increase
to the large activity created by the online currency trading for the retail
investor. The forex market is an over-the-counter market, which means
that there is no main exchange or clearinghouse. This is contrary to the futures
markets which offer futures trading in “open outcry” and electronic
access; which is transparent pricing through a trading platform. This en-
ables one to see the bids/asks and size, otherwise known as the “depth of
market” (dome).
In this book, we will be looking at the different aspects of trading the
currency markets, including the advantages and disadvantages of trading
the forex market. In addition, you will learn how to use other resources to
make better decisions on when to enter or exit your forex positions. Trading
the forex offers leverage, leverage that the individual controls. Through
the use of margin, an individual investor has the choice to increase or decrease
leverage through various means. Most currency firms offer 100 times
leverage on a regular size account; compare this leverage to the leverage offered
to the average equity investor, and you can see why many traders are
more attracted to trading the forex. As mentioned previously, leverage in
the forex market can also be customized to the individual trader, which
means that a trader can choose to lower or eliminate leverage while trading
foreign currencies.
FOREX VERSUS FUTURES MARKET
The futures market through the International Monetary Market (IMM) of
the Chicago Mercantile Exchange has many benefits as well. Founded in
1898, CME is the leader in the FX futures arena, accounting for 96 percent
of all currency futures contracts traded on a worldwide basis. The Chicago
Mercantile Exchange pioneered this segment by offering the world’s first financial
futures contracts on seven foreign currencies in May 1972. Since
that time, it has continued to expand its reach in FX by introducing new
products, expanding its customer base and leveraging the market leading
technology found in CME Globex®, its proprietary electronic trading platform.
The exchange handles over a billion contracts valued at more than
$638 trillion on an annual basis. It is a public company; and as of August 18,
2006, the stock (CME) was trading at 461.35. Amazing, considering that
when this stock was first released in its initial public offering (IPO) in December
2002, it was trading at under 40 per share! The history of the exchange
and the innovator of the IMM, Leo Melamed, who brought foreign
currency trading to life, is legendary. It has allowed investors, large and
small, to trade foreign currencies exclusively for nearly 25 years before the
explosive growth of spot forex was available. As with any product, there
are strengths and weaknesses. I wish to share with you the facts so you can
determine which investment vehicle suits your taste and trading style.
First, you should know the symbols for the individual futures currencies
as quoted against the U.S. dollar. There are just minor differences between
spot forex and futures symbols.
Note that futures trade in quarterly cycles; and to differentiate between
the various contract months, futures have universal symbols for each of the
different contract months. December is “Z,” March is “H,” June is “M,” and
September is “U.” Here is what you would use with a charting or quote ven-
dor to get a futures contract quote on a June 2007 euro currency—ECM7.
On some quote and charting services, the current year or the next contract
month going forward would be assumed and understood. The quotes symbols
for the different expiration months and various contract sizes of the futures
markets are confusing, but you can quickly learn these variables.
At times, the futures arguably have tighter “spreads” between the bid
and the asking prices; plus there is no interest charge or rollover fee every
other day. In addition, the futures markets offer options for longer-term
traders. There are transactions costs that apply per round turn; but if the
brokerage commission exchange, regulatory, and transaction charges are
less than the PIP spread in forex, an active speculator would be given a better
cost advantage using the futures markets instead of the forex spot market.
For example, let’s compare a trade in forex on a contract value similar
in size to one on the futures exchange. Use the example of a euro futures
contract on the CME with a contract size of USD125,000 worth of euros,
where each tick or PIP would be 12.50 in value. If the commissions and related
fees are $10, which is the average charge by most brokerage firms,
that is your transaction cost per round turn. That is $5 to buy and $5 to sell
out of the position. Keep in mind that the contract value is 25 percent
higher than a full-size forex position, too. If a day trader in forex trading in
a 100,000 full-lot-size contract pays two PIPs on every transaction of a position,
this trader would be charged $20 per round turn transaction. The futures
arena also has other interesting features and products; one is the U.S.
Dollar Index® contract traded on the New York Board of Trade. It is computed
using a trade-weighted geometric average of six currencies. It trades
virtually around the clock; the trading hours are from 7:00 P.M. to 10:00 P.M.,
then from 3:00 A.M. to 8:05 A.M., and then from 8:05 A.M. to 3:00 P.M. Unlike
the forex, there are daily limits on the price movement, with 200 ticks above
and below the prior day’s settlement, except during the last 30 minutes of
any trading session, when no limit applies. Should the price reach the limit
and remain within 100 ticks of the limit for 15 minutes, new limits will be
established 200 ticks above and below the previous price limit. The chart in
shows a breakdown of the six currencies and their respective
weights on the average. The top four include the euro, which is the heaviest
weight with 57.6 percent; then the Japanese yen with 13.6 percent; then
the British pound with 11.9 percent; and the Canadian dollar with 9.1 percent.
The Swedish krona is only 4.2 percent and the Swiss franc 3.6 percent.
Source: FOREX OR FUTURES: WHICH IS RIGHT FOR YOU?
