If you’ve decided to launch your investments in a brand new (uncharted-by-you) direction, have your thoughts drifted to futures or maybe forex?
Have you seen futures prices on the local news (corn, soybeans, pigs, precious metals, crude oil) and thought to yourself, “What’s all that about, anyway? Can I make money off of that?” The answer is a resounding, “Absolutely!”
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Futures and Forex
If you claim you’ve never participated in the forex market, pause for just a second. Have you ever traveled overseas? Maybe you’ve exchanged U.S. dollars for euros if you’ve gone to Germany or Italy. Or maybe you’ve turned U.S. dollars into yen on a trip to Japan.
If you’ve ever exchanged any money at all, you’ve made a foreign transaction and ultimately, made a tiny mark on the forex market. Now, multiply that action by trillions, and you’ve got the full-fledged forex market, an extremely liquid and gigantic market (it’s the largest in the world) which has an average daily trading volume of $5 trillion. On the other hand, futures are contracts, or more specifically, they are financial contracts to complete a sale or purchase in the future (that’s why they’re dubbed futures!)
A futures contract involves both a buyer and a seller. An agreement occurs between said buyer and seller regarding an asset, which will be bought or sold for a specific price on a specific day. The asset can be a commodity, a currency, or even an index.
When you trade forex, you’re simply buying and selling currency pairs, and the most often-traded currency pairs include:
- EUR/USD: The euro and the U.S. dollar
- USD/JPY: The U.S. dollar and the Japanese yen
- GBP/USD: The British pound sterling and the U.S. dollar
- USD/CHF: The U.S. dollar and the Swiss franc
When trading forex, you sell one currency (the base currency) in order to purchase another (called the quote currency). An example of how to read a forex quote is below:
Just like when you exchange your U.S. dollars for yen when traveling in Japan, you’ll also pay attention to the exchange rate when you’re trading forex.
The exchange rate shows how much you’ll pay in units of the quote currency to buy one unit of the base currency. In the example above, you’ll pay 1.5143 U.S. dollars in order to buy one British pound.
When you sell, the exchange rate reflects the number of units of the quote currency you will receive for selling one unit of the base currency. Note: If you want to buy (the base currency and sell the quote currency), forex lingo refers to this as “going long” and if you want to sell (the base currency and buy the quote currency), it’s referred to as “going short.”
For more details about how to make your first foray into forex trading, check out Benzinga’s How to Start Trading Forex for Beginners.
Since prices of commodities, for example, are constantly in flux, individuals or businesses use futures contracts to mitigate risk by locking in a fixed price at a future date.
Similar to forex, you’ll hear two terms that sound almost exactly the same in futures: “long position” and “short position,” and those refer to an agreement between two parties, the party who agrees to deliver a commodity (short position) and the party who agrees to receive the commodity (long position). The actual contract itself includes the following:
- The quantity and quality of the specific asset.
- The date and method of delivery of the asset.
- The currency unit involved.
- The unit of measurement.
Here’s a great video by TD Ameritrade that explains futures in a nutshell:
A few important questions to ask yourself before you enter into a futures contract include the following:
- What is the margin requirement? (This is easily the most risky part of futures trading. A commodities broker may allow you to leverage up to 20:1, which is much higher than any other market typically goes.)
- What is the spread (difference between the bid and ask?)
- How liquid is the contract? (The more liquid it is, the less it will cost for a contract to enter and exit the market.)
- Are the volume fluctuations or inconsistencies above or below the historic average?
Finally, you’ll need to choose a broker, and we’ve done the hard work for you with Benzinga’s The Best Futures Brokers Trading Platform
Pros and Cons of Trading Forex
- Sizeable leverage can turn a lot of money into a major profit.
- The forex market is extremely liquid and accessible.
- There’s no central exchange, and it’s decentralized and deregulated, all good things for traders who like consistency.
- Extreme volatility can occur in the forex market.
- There can be less regulatory control, but if you stick with U.S.-based brokers, you’re better off.
- Price determination can be tough to discern, particularly regarding foreign economies and global politics.
Pros and Cons of Trading Futures
- Futures trading involves an extremely liquid market.
- Costs are fixed in advance.
- Speculators can borrow a lot of money to trade futures.
- The greater the leverage, typically, the greater your potential gains.
- Futures are considered riskier than trading stocks, and that’s primarily because of leverage and the amount of leverage allowed. The potential for loss could be substantial.
- No industry standard for commission and fee structure through brokers.
In some ways, future and forex are so different, yet have similarities. They both employ leverage in order to maximize and move some major coin, which, of course, inherently comes with a side of risk as well. The great news is that you can spend a lot of time paper trading before you even begin in order to test your strategies.
If you start with a fairly simple trading technique and hone that particular strategy, paper trading (for months!) can truly be a great option and a great idea for brand-new forex or futures traders.
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