Hedging and speculation with currency futures on the market
The foreign exchange market is the largest in the world, its daily turnover exceeds $1 trillion. About 1% of this amount is accounted for by the currency market. futures. What are the differences between currency futures and traditional futures, and what strategies are effective when using these derivatives?
Currency and traditional futures
Both traditional and currency futures involve the use of the same principle: the contract provides for the sale or purchase of a certain volume of an asset at a certain price at a predetermined time. The main difference between them is that currency futures are not traded centrally. Transactions are made on various trading floors both in the U.S. and abroad. Most currency futures are traded on the Chicago Mercantile Exchange.
This does not mean that transactions in currency futures are illegal because they do not fall under the jurisdiction of U.S. law. Currency futures are still subject to a number of certain rules and restrictions. It is important to keep in mind that, unlike the spot foreign exchange market, quotes of all, without exception, currency futures are expressed in terms of the dollar.
Providing the trader the opportunity to trade in currency futures, the broker must provide him with all the information about the futures: the size of the contract, time intervals, trading hours, price limits, etc.
Spheres of application of currency futures
The main areas of application of currency futures - speculation and hedging. At hedging The use of currency futures makes it possible to reduce or even completely eliminate the risk associated with abrupt changes in exchange rates. The goal of speculation, of course, is to make profits at the expense of exchange rate differences.
Hedging currency futures
The currency futures hedging strategy is popular for a number of reasons.
Hedging, is used to reduce the risks associated with sharp price changes on sales income. For example, a trading company with a retail network in the European Union wants to specify the amount of profit expressed in dollars. In order to do this, the company needs to buy a futures contract whose size is equal to the expected profit.
It is worth noting that When hedging, the trader has a choice between futures and forwards (forward contracts). These derivatives have several differences:
- Forward contracts do not have large restrictions on the size of the contract and time, which makes it possible to adjust the contract, depending on the requirements of the trader. In operations with futures, the contract has a fixed size.
- Payment for a forward contract is made upon expiration of its term. Settlement for futures contracts is made on a daily basis.
- When using futures contracts, the trader can reassess his positions as often as he wants. When using forward contracts, one must wait for its expiration date.
Currency futures speculation
Currency speculation, in and of itself, involves making profits from exchange rate differences. In this case the use of futures and spot is not so different, although it has a number of advantages and disadvantages.
The benefits of speculating in currency futures:
- Spreads have a smaller size;
- Transaction costs are lower;
- Leverage is over $500 per contract.
Disadvantages of speculating in currency futures:
- Solid capital is required;
- Restriction on the time of trading sessions;
- National Futures Association (NFA) can make demands for certain contributions.
Strategies and trading systems for speculating on currency futures are virtually the same as those used in the spot market. They are based, as a rule, on the principles of technical analysis, Fibonacci rules, Gann rules and others. More sophisticated arbitrage strategies may also be used.
As you have noticed, using currency futures is no more complicated than using futures contracts on the stock or commodities market. By using currency futures, a trader opens up new opportunities for hedging and speculation, which can significantly affect the efficiency and profitability of trading.