FOREX FOCUS
Forward Contracts Vs. Spot Currency
Here are some methods you can use to trade currency pairs that are just as or even more profitable than trading the spot market.
What most traders understand about currency trading is the basic buying and selling of currency pairs based on what the indicators will determine. These are basic trades that take place in the spot market. But in the spot market there is much more than just these basic trades. Since interest rates between two pairs are the overall driver of spot prices, there are other methods to trade pairs. Arbitrage, forward contracts, bond yield correlations, and spot differentials in interest rates, referred to as swaps, are just a few opportunities I will examine.
Opportunity for arbitrage
Arbitrage opportunities exist to take advantage of the difference of interest rates between two nations. In currency trading, arbitrage simply refers to the simultaneous buying and selling of a currency pair to take advantage of interest rate differentials.
For example, look at the prime rate in the United States and the prime rate in New Zealand; the difference is 5 points. Say the difference between the prime rate in Japan and New Zealand is 5.5 points. The difference between these prime rates can be arbitraged. These types of arbitrage opportunities exist for many other pairs between nations. This is done through the forward contract that is traded over the counter.
A forward contract is an agreement between two parties to exchange different currencies at a future date. It is an unorganized market. Central banks, treasury departments, multinational corporations, banks, hedge funds, institutional investors, importers, and exporters are all active traders of these markets almost 24 hours a day, Sunday evening to Friday afternoon, Eastern time. All are using the opportunity of arbitrage to take advantage of the interest rate spreads that exist around the world. Some of these interest rate differentials are fleeting moments to longer-term spreads that can last as much as one year or more.