Billions have been made investing in both futures and Forex – but which one suits your investing style?
Before we delve into the hotly debated topic of which is better, futures or Forex, let’s take a look at the key differences between these two investment options. Put simply, investing in the futures market is quite similar to investing in the stock market, except that your trade purchases a right to buy or a right to sell specific stocks or commodities at certain prices. These prices are called the “strike price,” and generally rise as the length of your contract increases. To put this into perspective, imagine buying a “corn” contract on the futures market for $50 per ton. You are betting that the price of corn will increase to more than $50 per ton in the near future. If this never happens, you have simply wasted the money that it took to purchase the contract, but if the price of corn does exceed $50 you can sell your contract and turn a profit. Simply deduct the commissions and prices paid for the original contract and you’ll recognise your net profit. Most investors in the futures markets select commodities rather than stocks, as stock futures are generally referred to as “options” – although for the most part they operate in a similar manner.
Defining Forex is quite simple. A trader will select two specific currencies and attempt to earn a profit based on swapping these currencies at opportune times. For instance, a trader might assume that the value of the Euro will improve in the short term over the value of the US Dollar. By using a regulated Forex trading house, as well as a host of sophisticated software and support tools, the trader can complete this currency swap with the intention of earning a profit. This is obviously an oversimplification of the currency markets, but the basic transaction is actually fairly straightforward. Looking at both futures and Forex, which option makes more sense for the average investor, and which one will provide you with the quickest and safest return on your investment? Going forward we will define the pros and cons of both the futures market and trading in Forex.
7 or 24 hour marketplace? Here is one area where other investment opportunities find it quite difficult to compete with the Forex marketplace. From Monday to Friday, currency traders have around-the-clock access to a network of other traders who can facilitate currency swaps. No matter where you are in the world during the standard working week, you’ll find access to a 24 hour marketplace that provides seamless access to trading and an easy ability to react quickly to global market indicators. This contrasts sharply with the futures market, which relies on the opening and closing bells of the stock exchange to bookend the trading day. If important news comes in from Japan, Europe, or virtually anywhere around the globe while the US futures market is closed, the next morning may present market volatility for futures traders. In contrast, Forex traders have the ability to react immediately to any global events that may cause a shift in currency value.
Liquidity: To cut to the chase, the Forex market is the largest and most liquid marketplace in the world. Able to absorb significant trading volume and massive transaction sizes with ease, more than $5.3 trillion is traded on a daily basis by those looking to make a profit on currency swaps. While the size of the market isn’t always an indicator of its profit potential, the futures market simply does not have the potential to compete with Forex when it comes to liquidity. To the trader, this means that currency positions can be liquidated and stop orders completed without much concern for slippage (with the exception of trading within severely volatile markets).
Commission structure: The Forex market does not work within a specifically regulated and centralised marketplace. This means that Forex trades do not require the use of a broker who will demand commission in exchange for his/her services. When trading in futures, commissions and other related fees are simply part of the course, and must be considered when creating a financial plan based on your investments. Brokerages and trading firms who support and facilitate Forex trades earn their money in several ways, with slight premiums on the currency valuation being the cost that most closely aligns with a traditional broker’s commission.
Minimal risk: While there is always going to be some level of risk within any investment opportunity, the process of investing in currencies through a reputable trading firm automatically provides some risk mitigation in the form of position limits. A position limit is a number that is established relative to the amount of money in a trader’s account. Online trading platforms will automatically create a margin call if the predetermined margin exceeds the amount of trading capital within the related account – thereby minimising losses and protecting your investment. When investing in futures, you may be liable for significant deficits if the position is liquidated at a loss that is larger than what you had in your related account.
Leverage: Though the concept of leverage can be both a good thing and a bad thing, having access to high leverage positions can enable you to make serious profits with a minimal upfront investment. Forex traders often allow up to a 500 to 1 leverage ratio, though most new traders should start with a much lower ratio to hedge against the potential for losses.
As in most things, there is no one winner when it comes to determining which is better – Forex or futures. If you enjoy participating in an investment that rewards quick thinking, market awareness, and continual learning, then the Forex option is likely for you. If a “purchase and hold” scenario sounds more appealing to your investment style, consider investing in futures. Again, there is no right or wrong answer, but consider your level of risk tolerance, your appetite for profitability, how involved you want to be in your investments, and the fees that you are willing to pay for your investment, and you’ll discover the answer on your own. From a market trade volume viewpoint only, Forex drives more than 150 times the daily trade volume compared to futures – possibly the greatest indicator of the difference in potential for profits between these two investment opportunities.