A Better Way to Trade FX Futures

11/26/2009 12:01 am EST

Focus: FOREX

John Jagerson

Co-Founder and Contributor, LearningMarkets.com

Currency traders debate the benefits of over-the-counter (OTC) style forex and currency futures available on an exchange. These instruments are very similar, yet there are some key differences. We have compared the pros and cons of forex versus futures in earlier articles, and the balance usually shifts to the OTC style for one reason: Flexible contract sizes.

Many retail forex traders cannot trade full-sized lots (100,000 base currency units) and maintain proper risk management. Almost all OTC forex dealers offer a "mini" version of a forex lot that is one-tenth the size of a full-sized lot, or 10,000 units of the base currency. These mini lots are ideal for smaller traders who want more control over their market exposure.

In the past, currency futures have only been available in full-sized lots, and in a few cases, a half-sized lot. However, the balance has shifted with the introduction by the Chicago Mercantile Exchange (CME) of E-micro currency futures. These micro lots are priced like an OTC mini lot at 12,500 - 10,000 units of the base currency.

Perhaps the most significant advantage of currency futures over the OTC market is transparency. An exchange traded product helps to eliminate counterparty risk. This means that the exchange aggregates buyers and sellers without acting as the counterparty to each trade like a dealer does in the OTC market. Because the exchange works like this, pricing, spreads, and commissions are a product of a more competitive process.

The CME will provide equal access to order depth and volume information to retail and institutional traders. This provides a lot more information about market liquidity and volume than OTC forex traders have. Typically, OTC traders have no access to reliable order depth or volume data.

The video accompanying this article will go into more detail about how trading costs compare with the spot forex and why traders may want to consider having accounts to access both markets. There are still some advantages forex dealers can provide in the OTC that the exchange cannot. However, for access to the six most actively traded currency pairs, the futures exchange may be an ideal alternative to some of the bucket shops in the forex.

Watch the video now for more information:

By John Jagerson of LearningMarkets.com

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