Which to trade - Forex, Futures, Or Options on Futures?
Both futures and forex trading have their advantages and disadvantages.
Trading forex - or foreign currency pairs - gives greater leverage than outright futures trading, of up to 100:1.
This means that for every $1000 put up in margin, you can trade with up to $100,000 in currency value. If you put up $10K, you could trade with $1 Million of currency. This means that if there is a 1% move in the value of the currency pair that day, it would give you a profit/loss of $10,000, or 100% change on your investment. This would be great if you were right, but disastrous if you were wrong as you would have lost your entire trading account.
Trading futures, you usually get leverage of around 2%, so you can do twice as much with your money trading forex (losing twice as much as well as winning twice as much. Money management is important!). If you are swayed to forex because of the increased leverage, hang on a minute because you may be able to get much more leverage using options on futures...
Deep out the money options will cost little but if you are right on your prediction, you could make a vast sum in a short period of time. For example, Feb Gold is trading at 455.00 on December 3rd 2004. You expect a sharp drop in prices to trend-line support at 435. You have $100,000 to trade with. 435 Feb gold puts are priced at $500 each - quite cheap as they are deep-out-the-money. You have enough to buy 200 puts $500 x 200 = $100,000.
On Dec 10th, the market has plummeted to 435 and you exit your position by selling your 200 puts. In effect, you sold the futures at 455 and bought futures at 435, giving a profit of $20 per contract. There are 100 troy ounces per contract so you make $2000 per contract. You bought 200 contracts so you have made $400,000 in a week, or 400% on your money while the market has dropped less that 5%.
If you had done an outright futures trade, you may have had to put up $2000/contract in margin, so you could only have traded 50 contracts as opposed to the 200 using options. If you had sold 200 futures at $455 and bought at $435, you'd have made $200,000 or 200% on your investment.
For more on the pros and cons of trading futures options, see here.
Trading forex has the advantage of being commission free. The forex broker is compensated for its services through the spread between the bid/ask prices.
Spot currency trading is a worldwide inter-bank market that allows buyers to be matched with sellers instantly. Although you do not pay a commission charge to a broker to match buyer up with seller, the spread is usually larger than trading futures.
For example, trading a Japanese Yen/US Dollar pair USDJPY forex trade would have a 3 point spread worth $30. Trading a JY futures trade would more likely have a spread of 1 point worth $10 but you would also be charged the broker's commission. This could be as low as $10 in-and-out for self-directed online trading, or as much as $50 for full-service trading that may include live assistance, help and advice from the broker. You need to compare both online forex and your particular futures commission charge to see which "commission" is greater. Chances are they actually work out about the same.
Forex trading is a 24-hour market, trading 5-days a week. Opening hours follow the sun around the world from one country to another e.g.
In recent years, most futures markets also trade around the clock too, on the GLOBEX markets.
Charges on Your Account
Forex trades carry an interest charge of around 1% per year. This may sound small, but with the high leverage of forex trading, you can trade with a lot larger amount of forex than in your account.
For example, you have $50,000 to trade forex. There is 100:1 leverage allowing you to control $100,000 with $1000 margin. Therefore, with your $50,000 you can trade $5 million of currency. If you fully margined your $50K for a year and ended up breaking even on your trades, the 1% interest charge will cost you $50,000 - your entire account value!
Even trading smaller amounts, the interest charges can add up. For example, you have $100,000 in your trading account and use $30,000 in margin. Over a few weeks, some trades go your way and some do not, some positions are stopped out and a couple are left on the market. You have a profit of $3000 from all your trades, or 10% on your margin. But the interest charges could amount to perhaps $1000, or 30% of your profits.
With futures, there is no interest charged on your account or positions.
Exchange Rates
If you are located in a country other than the
For example, you are British and want to open an account trading US futures markets. You convert £50,000 British Pounds Sterling into US Dollars at an exchange rate of 1.8000 USDGBP and get $90,000.
Six months later, the dollar has fallen in value against the Pound and you could now get 1.9500 USD for every GBP.
Were you to not make any trades at all during this period, or your trades had broken even, and you then decided to convert your dollars back in Sterling, you would only get £46,154 less the spread and commission fees. You would also have received no interest on your money while it was sat in your trading account, whereas you may have got - perhaps - 5% had you left it in a UK bank account. This has devalued your money in the 6-month period.
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