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Forex futures: A primer
The forex futures market accounts for more than $200 billion in daily trade. Can it can help you with your money?
The forex market is a behemoth — on average, $5 trillion moves through it every day. Of course, with such a large pie, you’re going to have many smaller slices of action used for different purposes One of those slices is the forex futures market.
Let’s talk about futures and how they can help you with money transfers, investments and more.
What is a forex future?
If you’re trading a forex future, you’ll probably be doing so through the Chicago Mercantile Exchange (CME). The CME is one of the world’s largest derivatives markets, and it moves huge volume in forex futures.
What do you use forex futures for?
Now for the important question: How can a forex future help you?
Consider the idea that forex futures are all about … well, the future. Think of them as tools that help you make or save money later on. There are two big reasons you might use a futures contract: hedging and speculating.
Hedging in forex is insulating yourself from poor movements in currency exchange rates. You get the advantage of locking in a good price for later, which can pay off handsomely in the long run.
For example, let’s say your international client will pay you 125,000 euros in six months. Because your business is in the United States, you’ll convert those euros to US dollars. Let’s pretend 1 euro is currently worth $1 — so 125,000 euros is equal to $125,000.
Six months is a long time, and the value of the euro can fluctuate dramatically in the meantime. But you don’t want to roll the dice on exchange rates — you just want to get paid what you’re owed.
Since you know you’ll be receiving 125,000 euros in six months, you could use a futures contract to ensure that someone will give you around $125,000 for that amount six months later.
On the flip side, forex futures are also used for speculating — that is, buying or selling assets with a lot of risk but potentially big paydays.
For example, let’s say you think the euro is about to go down in value. You want to make what’s called a speculative bet. Here, you can take out a futures contract promising to use US dollars to buy euro at a specified time.
Now, two main things will happen if the contract matures:
- Your bet is incorrect, and the euro has gone up in value against the US dollar. This means the euro has become more expensive. You’ll lose money, because you’re obligated to buy it at a disadvantageous price.
- Your bet is correct, and the euro has gone down in value against the US dollar. Because the euro is cheaper, you’ll make money because you can buy euro at a more advantageous price.
Usually, a trader doesn’t hold on to a futures contract until it matures. More likely, you close out the contract before it matures, depending on the prospects for making a profit. Essentially, you do that by taking out an opposite trade to the one you’ve made to open the futures contract.
Speculating can bring big profits, but it’s also risky. If you want to hop in the game, study up and be sure you know what you’re doing.
Compare international money transfer options for hedging
How forex futures work
To understand the basic mechanics behind futures, you should first understand three important terms: trading units,tick sizes and tick values.
A trading unit is the size of one futures contract — for example, 125,000 euros. It’s how much money is represented by the contract.
The tick size is the smallest amount that a futures price can change. For example, a EUR/USD contract has a tick size of 0.0001 — it’ll move in increments of 0.0001.
The tick value is how much each tick is worth in cash. Using our previous example of 125,000 euros, the tick value for the EUR/USD contract would be $12.50. That means if the price of the contract moves 0.0001 either way, you’re looking at a profit or loss of $12.50.
Here are trading units, tick sizes and tick values for a few common currency pairs (these are standard futures contracts):
|Contract||Trading unit||Tick size||Tick value|
You can also trade E-micro futures contracts, which are a tenth of the size of standard contracts. Look at how the trading units and tick values change with an E-micro futures contract:
|Contract||Trading unit||Tick size||Tick value|
Why all the talk about trading units and tick values? It’s because when you’re trading a future, you’re actually using a small amount of money to control a larger amount of money — that’s called leverage. (You use leverage for normal forex trading too, but you use it to a greater degree for forex futures.)
So the trading unit of a EUR/USD contract might be 125,000 euros, but that doesn’t mean you have to pay 125,000 euros to trade it. Instead, you could control a contract of that size with a deposit of a few thousand dollars.
Next steps: Should you use forex futures?
If you’re looking into forex futures for your business, you’ll probably be using them for hedging. If you know you’ll need to make a money transfer or international payment, for example, you can open a futures contract and rest easy knowing you don’t have to worry about fluctuations in the exchange rate.
As investments, forex futures should be approached carefully. Speculating with them can be wildly complicated, and you’ll need to consistently produce accurate predictions about where the market’s moving.
To get started with forex futures, open an account with a forex broker like OFX.
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