Should You Trade Forex Or Financial Futures?

Today's futures market can trace its origins back to the agricultural markets of the 19th century when farmers began entering into contracts to deliver agricultural products at some date in the future for a fixed price in order to stabilize supply and demand across the different seasons of the year. Today the futures market has expanded to include far more than simply agricultural products and includes not only commodities but also financial instruments such as currencies and treasury bonds.

Many of the participants in the market today are speculators rather than traders and the actual commodities or financial instruments are unimportant as it is the futures contract itself which is actually traded as it rises and falls in value over time according to the value of the underlying commodity or financial instrument.

If that sounds complicated let's try to simplify things a little bit by looking at an example using an agricultural commodity. Suppose a farmer is supplying wheat to a baker and agrees to sell him 100 bushels of wheat at $6 a bushel with delivery being set for some specified future date. If the price of wheat were to remain constant then on the specified date the farmer would simply deliver the wheat and would then be paid $600. However, the price of wheat is unlikely to remain constant and indeed is quite likely to change on a daily basis and this is where the futures contract for this particular transaction comes into play as it is valued at the end of each day in the period between the date on which it was drawn up and the date on which the wheat is finally delivered.

So, let's assume that on the day after the contract is drawn up the price of wheat falls to $5 a bushel. At the close of business on this day the farmer's account would be credited with $100 ($6 - $5 x 100 bushels) and the baker's account would be debited with the same amount. Similar payments would then continue to be made back and forth between the two accounts as the price of wheat rises and falls each day until delivery is effected and the final payment is made as originally agreed.

So where is the benefit to the farmer and the baker? Well, let's assume that the price of wheat fell as shown above by $1 a bushel the day after the contract was drawn and then remained steady throughout the rest of the period. On settlement day therefore the price of 100 bushels of wheat on the open market is $500. At this point the farmer has made $100 on the contract and the baker has lost $100. However, because the baker can now buy 100 bushels of wheat on the open market for just $500 he does so and, together with the $100 he has lost on the contract ends up paying the price he had originally intended to pay of $600. Similarly, the farmer now has to sell his wheat on the open market at a loss of $100 but, since he has already made $100 on the contract he is no worse off and still ends up getting $600 for his wheat.

In this case the baker has lost out paying $100 more than he needed to for his wheat but has nonetheless managed to buy it at a price which he had originally budgeted for. What he has done however is to protect himself from the possibility of a rising market. For example, had the price of wheat risen to $8 a bushel, without a futures contract, he would have had to pay $800 on the open market.

Speculators working in the futures market buy and sell futures contracts in the hope of profiting from the daily fluctuations in the values of those contracts. For example, a speculator will buy a contract from the buyer if he expects prices to rise (buying long) and will buy a contract from the seller if he expects prices to fall (buying short).

The futures market is a complex market and one problem with the market is that it is governed by the law of supply and demand which means that it is not always as easy as you might like to either buy or sell futures contracts. This is particularly true of some sectors of the market in which supply and demand can be generally quite low and also fluctuate significantly.

By contrast the Forex market is the world's largest and most liquid financial market and the one market in which the law of supply and demand really does not apply. Open 24 hours a day 7 days a week (in contrast to most futures markets which are open for just 7 hours each day) there are always opportunities open to buy and sell the world's major currencies.

As if this were not enough, Forex transactions are commission-free with brokers earning their money on the spread in the price between buying and selling currencies. These spreads too are the lowest you will find in any financial market.

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If you are tempted to look to the futures market as an investment vehicle to make your fortune then, before you do so, take a moment to consider the Forex as an alternative. Many millions of small investors are committing themselves to learn Forex every day and, with the small capital investment required to enter the world of Forex trading, are finding that it is one of the smartest decisions they have ever made.