Currency pairs or currency futures
Traders make money on changes in exchange rates using a variety of financial instruments. The most popular ones include Currency pairs and currency futures. These instruments have similar characteristics, so they are suitable for solving the same problems. For example, a trader can make money on the growth of the exchange rate of the U.S. dollar against the euro using both a currency pair on the spot market and the corresponding futures contract.
However, currency pairs and futures have differences that determine the peculiarities of trading these instruments. However, even experienced traders do not always understand the difference between pairs on the spot market and futures contracts. As a result, they choose inappropriate financial instruments. It complicates the realization of trading strategies, increases costs and leads to unnecessary losses.
Investors should understand the difference between futures and currency pairs and be able to choose the instrument most suitable in a specific situation.
Currency pairs: round-the-clock trading with minimal investments
Currency pair - an instrument of the Forex market, by means of which spot trades with currency are carried out. For example, the pair EUR/USD is used to trade the euro against the U.S. dollar. Daily turnover of the Forex market is about 4 trillion dollars. This provides high liquidity of trades in popular pairs. Liquidity provides traders with the ability to quickly open and close positions and earn on minimal intraday fluctuations in quotations.
Using currency pairs in the Forex market, the trader has the opportunity to trade with leverage. This allows him to make transactions, the volume of which significantly exceeds the size of the deposit. Forex brokers require the provision of margin on the spot market, which on average is 0.5-3% of the transaction volume. That's why Forex trading with currency pairs is suitable for experienced traders who need big leverage.
Spot market trading with currency pairs provides investors with other opportunities, including:
- Flexible choice of lot size. When trading currency pairs, the investor independently controls the volume of open positions. His strategy and risk management are not limited to standard sizes of exchange-traded contracts, such as options and futures.
- Round-the-clock trading on weekdays. Banks provide investors with the ability to make transactions 24 hours a day. Using currency pairs on the spot market, an investor can react instantly to changes in the market situation at any time.
- Trading without commissions and exchange fees. When opening and closing positions in the spot market, traders usually pay brokers only spread.
- Holding a position for an indefinite period of time. By trading currency pairs on the spot market, a trader can theoretically maintain a position indefinitely. This is convenient for long-term investors who get an opportunity to save on commission costs.
Risks of trading currency pairs
When trading currency pairs in the Forex market, investors are also faced with the disadvantages and risks of this tool. First of all, Forex is OTC market. It is considered the least regulated financial market on a global scale. In the Forex there is no unified exchange platform or a central supervisory authority capable of preventing manipulation or resolving a dispute between the client and the broker.
In practice, the absence of a central exchange can prevent traders from making informed investment decisions. For example, spot market participants cannot accurately assess current trading volumes and the size of open positions. And these data are important indicators of market sentiment.
Secondly, despite the absence of commissions on transactions in the spot market, the costs of traders often exceed the costs of stock traders. The fact is that most brokers increase spreads when liquidity drops. As noted above, there is no central regulator in the Forex market. Therefore, it cannot be guaranteed that brokers never artificially increase spreads.
ThirdTheoretically, brokers can trade against the client. This possibility is again due to the lack of central regulation and the peculiarities of the business model of most brokers. Forex providers usually make money on spreads. They earn income whenever a trader opens or closes a position. By trading against the client, the broker may force the client to make transactions more frequently. Therefore, for protection purposes, it is worth choosing a broker that regulates the Forex system.
Currency futures: safe trading on organized marketplaces
Currency futures - exchange market instruments by means of which futures transactions with underlying assets are carried out. Futures contracts allow a trader to buy or sell a selected currency at a certain time at a predetermined price. Currency futures trading on exchanges is characterized by high liquidity. For example, the average daily turnover of all futures contracts on the Chicago Mercantile Exchange (CME) exceeds 100 billion U.S. dollars.
Currency futures are traded on regulated exchanges overseen by central regulators, such as the U.S. Securities and Exchange Commission (SEC). This determines safety and transparency trading futureswhich is considered one of the main advantages of this instrument. When trading currency futures contracts, the investor has the opportunity to assess the volume of trading and the value of open positions at any time.
To others benefits currency futures include:
- Minimum likelihood of price manipulation, because the trader buys futures from other bidders, not from the broker.
- Transparent pricing and predictable trade costs. Providers of access to exchange trading are usually remunerated in the form of a fixed commission. This protects investors from the unpredictable costs associated with artificially widening spreads.
- Ability to hedge currency risks. As noted above, futures contracts allow a trader to buy or sell a currency at a specific time at a predetermined price. Private and institutional investors use this to protect portfolios from strong unpredictable changes in the currency market.
- Transparency of contract execution. Thanks to centralized clearing of futures contracts, traders can count on accurate and timely netting of obligations.
Risks of futures trading
Futures contracts have a limited circulation period. This determines main riskassociated with the use of this tool. By implementing a medium or long-term strategy, the trader maintains an open position for a long period of time. However, he must close the position on the expiration date of the futures and buy new contracts, which is associated with the commission costs. In addition, as the expiration date approaches, the liquidity of trading in specific futures contracts usually drops. Therefore, investors are faced with the need to sell futures contracts on unfavorable terms.
Another disadvantage of trading in currency futures is associated with lower compared to the spot market speed of order execution. In practice, the delay can be several seconds. This is inconvenient for traders implementing aggressive strategies, because it deprives them of the opportunity to take advantage of short-term market fluctuations.
Currency pairs or futures: what to choose
Currency pairs and futures allow investors to make money on changes in exchange rates. They have differences that must be considered when choosing a financial instrument. Currency pairs are more suitable for traders focusing on aggressive short-term strategies such as scalping. By trading pairs on the spot market, traders can count on instant order execution, no commissions and no exchange fees. Currency pairs are also suitable for long-term investors who hold positions for a long period of time. By using this tool, they save money on commission costs associated with the need to close positions on expiry time.
Currency futures are suitable for traders who need a safe and transparent financial instrument. Futures contracts are traded on exchanges that control pricing, perform centralized clearing and prevent price manipulation. In addition, futures are classified as indispensable tools for investors in need of hedging currency position. These contracts allow you to buy or sell currency at a certain date at an agreed price.