Forex Investment and Currency Trading

The overwhelming majority of Forex trading volume is in the spot market. “FOREX” inevitably means spot trading to most participants. But it is possible to trade FOREX as a futures vehicle. The volume of futures FOREX has also increased. The primary advantage of futures FOREX lies in the fact that the futures markets are centralized and as such are more heavily regulated. A secondary advantage is that many popular technical trading methods use volume of trading and open interest. While aggregate volume is known in FOREX, daily figures are unobtainable because of the decentralized nature of the business.

A futures contract is an agreement between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. For example, a grain farmer would be the holder of the short position (agreeing to sell the grain) while the bakery would be the holder of the long (agreeing to buy the grain).

In a futures contract, everything is precisely specified: the quantity and quality of the underlying commodity, the specific price per unit, and the date and method to delivery. The price of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the grain scenario, the price of the contract might be 5,000 bushels of grain at a price of four dollars per bushel and the delivery date may be the third Wednesday in September of the current year.

Currency Futures
The FOREX market is essentially a cash or spot market in which over 90 percent of the trades are liquidated within 48 hours. Currency trades held longer than that are normally routed through an authorized commodity futures exchange such as the International Monetary Market. IMM was founded in 1972 and is a division of the Chicago Mercantile Exchange (CME) that specializes in currency futures, interest-rate futures, and stock index futures, as well as options on futures. Clearinghouses (the futures exchange) and introducing brokers are subject to more stringent regulations from the SEC, CFTC, and NFA agencies than the FOREX spot market (see www.cme.com for more details).

It should also be noted that FOREX traders are charged only a transaction cost per trade, which is simply the difference between the current bid and ask prices. Currency futures traders are charged a round-turn commission that varies from broker house to broker house. In addition, margin requirements for futures contracts are usually slightly higher than the requirements for the FOREX spot market.

U.S. Dollar Index
The U.S. Dollar Index (ticker symbol — DX) is an openly traded futures contract offered by the New York Board of Trade. It is computed using a trade-weighted geometric average of six currencies (EURO, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc).

IMM currency futures traders monitor the U.S. Dollar Index to gauge the dollar’s overall performance in world currency markets. If the Dollar Index is trending lower, then it is very likely that a major currency that is a component of the Dollar Index is trading higher. When a currency trader takes a quick glance at the price of the U.S. Dollar Index, it gives the trader a good feel for what is going on in the FOREX market worldwide.