Inside The Futures World
Want to find out how the futures markets really work? DeCarley Trading senior analyst and broker Carley Garner responds to your questions about today’s futures markets. To submit a question, post your question at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books Currency Trading In The Forex And Futures Markets; Commodity Options; and A Trader’s First Book On Commodities, are available from FT Press.
SIDE BY SIDE
What are the advantages of trading forex and currency futures side by side?
If you’ve been a regular reader of this column or have had the opportunity to read my latest book Currency Trading In The Futures And Forex Markets, you might have gathered I favor currency speculation in the futures markets relative to forex. There are several arguments for and against each venue, but the safety of regulation and customer segregated funds offered to futures traders appeals to me. That said, there are certainly times in which having access to the forex markets can be beneficial.
Three instances in which traders can benefit from trading forex are when:
Trading small quantities in off-market hours, or currency pairs other than the highly liquid EUR/USD
I’ve discussed the CME Group’s relatively new line of emicro currency futures before and we’ve touched upon the fact that these products sometimes suffer from a lack of liquidity. Despite having good market makers to improve the ability of traders to execute at fair prices, there are times when efficient execution is challenging. In many instances, forex pair traders might find favorable execution using forex mini contracts (10,000 units) due to smaller pip spreads, particularly during the off-hours such as late afternoon. Tighter spreads lower the overall transaction costs and mitigate some of the frustrations of entering and exiting a market with slippage in pricing.
A margin decrease in currency futures by the exchange lags the constantly adjusting forex margin
Forex margin is a ratio of the contract value, rather than a consistent figure as is the case in the futures markets. Forex margin requirements are fluctuating with market prices. As the EUR/USD rallies, the required good faith deposit increases; and as the EUR/USD declines, so does the required margin deposit.
Conversely, in futures, the CME Group, or any other exchange offering currency futures, sets what it believes to be an appropriate margin rate for each currency contract. This rate tends to stick for months, or even years, before it is adjusted. Because of the discrepancies in margin policy, there can often be significant differences in the leverage available to traders in each venue.
For example, if the EUR/USD forex pair is trading at $1.3300, the National Futures Association–stipulated 50-to-1 leverage ratio equates to just under $2,700 per standard contract of 100,000 units.
At this writing, futures trades could execute a standard-sized contract of 125,000 units (note the relative size difference) for $4,725. To compare apples to apples, we must assume the contract sizes are the same. If a forex trader were trading 125,000 units rather than 100,000, the margin requirement would be $3,325 (($1.33 x 125,000) x (1/50)).
A forex trader can benefit or suffer from price changes of 125,000 units of the EUR/USD with $1,400 less on deposit than a futures trader could. Traders who aren’t pushing the leverage limits might be indifferent, but those with aggressive strategies will find an advantage to trading forex based on these circumstances.
The margin benefit can swing in favor of futures, so don’t make assumptions.
Scalping high quantities intraday
Because futures brokers provide traders with discounted daytrading margins, they have the freedom to implement a highly leveraged scalping or short-term daytrading strategy, which wouldn’t be possible in forex due to a mandatory 50-to-1 leverage ratio. I am not necessarily a fan of utilizing such high levels of leverage, but if you’ve found a way to trade such a strategy, it is important to be aware of the limitations of daytrading in the forex markets relative to futures.
For instance, a forex trader would need $3,325 on deposit to trade 125,000 units of the EUR/USD; don’t forget the standard size is 100,000, but we are adjusting for comparative purposes.
A futures trader who enters the market intending to exit before the end of that day’s session might be granted margin rates a fraction of the CME Group’s margin. Some futures brokers advertise daytrading margin rates in euros of less than $500! If you’ve done the math, you know this is about $2,825 per contract less than the required forex margin.
Although this type of arrangement benefits the brokerage firm rather than the client, because it encourages higher trading volume and more commission paid, it is something to be aware of. Those trading large numbers of contracts at a time in hopes of small profits (a pip or two) wouldn’t be able to do so in forex but would in the futures markets.
The optimal arrangement for traders is to use a brokerage firm capable of meeting its needs for both futures and forex trading within the same trading platform. Although funds are held in two separate accounts, once you are logged into the platform, everything is netted as if it were a single account. In addition, using the same broker for futures and forex opens the door to convenient transfers between the two accounts. Good luck!