Speculative traders are constantly on the lookout for short-term opportunities on the market. Asset classes such as stocks, options, cryptocurrencies, forex and futures are among the most volatile and present a plethora of opportunities for short-term gains. Forex refers to the trading of currency pairs to take advantage of the ever-changing relations on global markets, such as new trade deals, macroeconomic news, policy changes, etc. The futures market may involve anything from commodities and stock to forex. A futures contract is an agreement to buy the asset at a predetermined price and date in the future. These two asset classes attract a lot of capital both from institutions and retail traders.
What is the difference between Forex and futures and which is a superior choice for traders? If you are curious about the similarities and differences between forex and futures and would like to know more about them before you trade, this guide is for you
Overview of Forex and futures markets
The Forex and futures markets are both characterized by good volatility and liquidity, but there are a few key differences that make the trading experience significantly different.
The forex market is where traders exchange currencies to profit from the difference. Traders use Forex to hedge against exchange rate risk and steadily increase their capital. Forex is characterized by high liquidity, which makes spreads pretty tight. Currencies on the Forex market are represented as pairs. Trading Forex compared to futures is more popular throughout the world. There’s a large pool of Forex brokers to choose from and the barriers for entry are minimal.
Futures markets allow traders to exchange the underlying assets for fixed prices at specified dates in the future. Futures contracts come with an obligation for buyers and sellers to fulfill their transactions at the specified conditions. The purpose of these contracts is to lock in underlying assets at fixed prices with the hope of selling them off at a higher price before the contract expires.
The volatility of a futures contract depends on the underlying asset and its price movements. Futures contracts also come with the obligation to deliver the physical goods upon expiration, which makes trades urgent and much of the additional risk applicable to futures trading is derived from the time-sensitivity of the trades. Futures prices are also highly influenced by the expiration dates.
Difference between Forex and futures
The underlying assets in forex trading are currency pairs of different countries. Traders make decisions based on the exchange rate derived by the bid and ask prices of the pair. The volatility of a given pair depends on the base and quote currencies and their respective economies. The price determined via trading is the official exchange rate of a pair, which is used by millions of people who do not directly engage in the forex markets through a licensed brokerage.
When it comes to futures contracts, the underlying asset can vary. This could be anything from stocks and commodities to cryptocurrencies and currencies. Unlike Forex pairs, futures contracts have an obligation to deliver the physical goods upon expiry.
Risk & Reward
When comparing any two different asset classes, the potential risk and reward is always going to be a key point of difference. Forex markets are known for high liquidity and volatility. The risk of short-term trading with currency pairs can be far riskier than a buy and hold strategy. However, due to the sheer degree of liquidity present on the forex markets, currency pairs don’t experience massive gains or losses percentage-wise. Which is why brokers are offering leverage to make profiting from small changes possible.
Futures on the other hand, are securities that are directly tied to the price of the underlying asset. The pricing of a futures contract takes the potential future value of the underlying asset into consideration, therefore, the bulk of the risk and profit potential in futures markets is derived from the performance of underlying assets.
Forex compared to futures has a different fee structure. Forex brokers generally charge traders with spread markups per trade or commissions. In addition, traders might experience inactivity fees and transaction fees. In addition to broker fees, Forex traders pay market fees, which are known as spreads. As already mentioned, spreads are the difference between bid and ask prices. In order to save fees on spreads, traders are looking for liquid markets.
Futures brokers, on the other hand, charge commissions per trade, which typically ranges between $1-2. The advent of online brokerages has meant that less and less brokers charge standard commissions per trade and charge account maintenance fees and spread instead.
Liquidity simply means that traders have the ability to buy or sell given assets without causing the drastic change in the asset’s valuation. When there’s good liquidity traders get the best prices. Large numbers of traders and large volumes create liquid conditions. Forex market is not centralized, which helps aggregate good liquidity. Keep in mind that some Forex pairs such as Major pairs are more liquid than Minors. Minor pairs are more liquid than Exotics. The Forex market is the most liquid market in the world as it has many participants. The list of participants includes Banks, Investment funds, retail and institutional traders, merchants, governments, large companies and more.
When it comes to futures, they are traded in regulated exchanges that make them liquid. However, the futures market is not as liquid as the Forex market.
One more difference between Forex and futures is scope. A forex trade is executed instantly and there are no limits on the amount of orders a trader can place throughout the day. This makes forex a viable option for both short-term trading and long-term investing.
A futures contract is an agreement between buyers and sellers which includes a specified future price and date at which the transaction must take place. This makes futures trading much more time-sensitive and the time frame of each contract is predefined in the contract. What’s more, futures have expiration dates which makes trading them more complex.
Forex markets are decentralized. Which makes regulating the market difficult. Regulatory bodies are licensing brokerage firms to increase the safety level. Overall, Forex markets are less regulated than other financial markets.
Futures trading is more tightly regulated than forex markets. While some futures trading may take place over the counter, a bulk of the activity comes from regulated exchanges.
Neither forex, nor futures traders are foreign to the concept of leverage. Leverage means that traders can increase their purchasing power using borrowed funds from their broker. Many traders borrow funds from their respective brokers to increase the size of their positions and bring in more profits while putting less of their initial capital on the line.
The core difference in leverage between forex and futures is the size of given leverage. Forex traders get the most amount of leverage of any other asset class. This is due to the outsized volatility and low profit margins that are characteristics of Forex markets. Many forex brokers offer leverage higher than 100:1, 500:1 or even 2000:1 (in some cases), which is unprecedented in other securities.
Futures contracts get less leverage, which may be more in line with the leverage available to stock and options traders. Typically, a leveraged futures position will have a 3-12% margin rate, which is referred to as a performance bond.
Choosing a high leverage is not always a wise choice. Yes, leverage can give you an ability to increase your income, but high leverage can just as easily result in increased losses. For this very reason leverage is often referred to as a double edged sword.
Due to all the differences mentioned above, it is no surprise that markets treat forex and futures in a different manner. The price, or exchange rate, in forex markets is determined by the prices of the base and quote currencies. Therefore, forex cannot be individually priced and always represents the exchange rate between a pair of currencies.
Future contracts, on the other hand, come with individual sets of instructions and obligations, and are individually priced because of this. However, the pricing of futures contracts depends on the underlying asset and its expected performance by the expiry date of the futures contract.
Forex trades are indefinite and can be repeated multiple times with no additional obligations to traders. Futures contracts are structured differently and an expiry date is mandatory for these securities. The core principle behind a futures contract is the agreement to deliver the goods at a specified price and time. However, traders can choose options as an alternative, which do not have the obligation to deliver the physical goods upon expiration. The purpose of traders is to sell the futures contract at a profit before it reaches the expiration date at which the underlying asset must be delivered.
Choosing between forex and futures
After carefully considering the core differences between forex and futures, it is important to have a clear understanding of your expectations with regards to trading objectives and performance. Factors such as volatility, trade frequency and leverage are among others that need to be considered in order to make the right call between forex and futures. For traders who are interested in high frequency trades with low fees and a highly liquid market that is subject to lax regulations, forex is probably the best choice. Traders who wish to gain exposure to a specific asset class and hedge against sudden price changes in the short term, may opt to trade futures instead.
Main takeaways from forex vs futures trading
- Forex trading involves trading pairs of real-world currencies used by countries from around the world
- Futures contracts are agreements between buyers and sellers to transact at a fixed price on a specified date
- Futures contracts come with the obligation to deliver the underlying asset once the contract expires
- Trading Forex and futures differs in many key areas, such as the use of leverage, time frame, risk and reward, regulations, trading fees and pricing
- Forex and futures are highly liquid markets that are substantially different in their makeup. Forex market is more liquid than the futures market.
FAQs on forex vs futures
Is futures trading more costly than Forex?
A single futures contract usually costs $1-2, while forex spread is typically much lower. Forex trading can be more cost effective when trading major currency pairs with a broker that offers low trading fees.
Which is better to trade Forex or futures?
There are many traders that prefer to trade Forex and there are traders that prefer futures. The profitability of forex and futures can vary greatly depending on the asset in question. Generally, forex is more volatile with lower profit margins, while futures contracts have a longer scope and charge more fees. The underlying asset of a futures contract can be anything from stocks to Forex pairs, which can be convenient for traders.
Is Forex riskier than futures?
Both assets are risky. In both markets traders are subject to high leverage. In Forex leverage is less risky as most brokers offer negative balance protection and stop outs. In addition, futures have expiry dates that add to the risks. Moreover, futures are generally more volatile than Forex pairs.