Forex vs. Futures
Trading
Which to trade - Forex, Futures?
Or Even 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. Having said that,
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. 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.
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. New York, London, Tokyo, back to New York.) This is good because
you can get in/out of a trade at any time. If there is a major announcement or
news story breaking that could effect the markets, you could log-in to your
account and make a trade. That is, if you can stay awake 24-hours a day,
5-days a week!
However, if you are a long-term forex trader, you may be
able to ride through the overnight trading activities. Or if you day trade forex
(short-term) you may like the fact that you can log-in whenever you feel like
it and trade for a few hours when it suits you.
Some futures markets trade around the clock, too, but many
markets are only open during US hours. This may be better for independent
traders who like to sleep for at least a few hours a day, then limit their
trading to a specified period.
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 United States of America and
need to transfer your local currency into US dollars to deposit into your
trading account, you should also be aware of the currency exchange rate.
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 3% had you left it in a UK bank
account. This has devalued your money by an additional £1350 in the 6-month
period.
If it all sounds too difficult for you to undertake, please consider our
managed trading systems.
Other Trading Articles
Futures Trading
Futures Trading
Learn the basics of trading commodity futures
Forex vs. Futures
Which should you trade? Forex or futures? Or Even Options on
Futures?
Futures and Options
Read our article describing the pros and cons of trading
futures with options
Online Futures Trading
An outline of the choices available when choosing an online
platform
Futures Trading Method
Day trading, tech, fundamental analysis
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