CASH FOREX TRADING

One of the fastest growing segments of trading in recent years has been in cash forex as dozens of new firms have sprouted up, taking advan­tage of online trading and less restrictive regulations. Controversy still sun·ounds the regulation of cash forex firms, and the National Futures Association and Commodity Futures Trading Commission have shut down a number of firms that they perceived to be “bucket shops” or perpetrators of fraud. In fact, sometimes the biggest risk in cash forex trading is not the mar­ket  risk from   changing currency values but counter-party risk-that is, the risk that the cash forex firm will not perform its obligations and will deal unfairly with customers. Because traders’ accounts t1epend on the creditwo1thiness and integrity of the cash forex firm with which they are dealing, evaluating a firm carefully is one of the first essential steps for the cash forex trader.

Nevertheless, cash forex trad ing offers a number of advantages  pro­vided traders are worki ng with a reputable dealer and understand the risks of high leverage available at some of these firms.

Low Entry Cost

 In some cases, traders can control a currency lot for only a few hundred dollars. A mini mal account size of $5,000 is typical, but in many cases traders can open a cash forex account for less money than an account to trade forex futures,which have standardized contracts that are generally larger than the forex lots traded in the cash market.

High Leverage

Traders can control a $100,000 position at a cash forex firm with $1,000-that is, 100-to-1 leverage. Forex futures may require 5 to 8 percent of the value of a forex contract in margin as a per­formance bond , but cash forex requires as little as a 1 percent margin.

Guaranteed Limited Risk.

The low initial requirements do not give traders much leeway for adverse price moves. However, many cash forex firms will take traders out of their open positions imme­diately when their equity falls below the required minimum amount.

Real-live Quotes to Trade

The cash forex firm provides traders with two-way bid and ask prices for a number of forex pairs via a free, streaming quote feed on a trading platform that usually also has some analytical capabilities, depending on the firm and the estab­lished arrangements. If traders click on the posted bid or ask price on  the screen, the position is theirs at that price instantly. There is no  slippage or a paitial fill as may occur with forex futures where prices are changing constantly. Real-time quotes for forex futures usually require the payment of exchange fees, which can mount up.

No Commissions or Fees.

Cash forex firms do not chai·ge commissions, as such. With stocks or futures, traders may have to pay $3.95 or $9.95 or even $100 in commission rates for every trade. Cash forex firms do not mak e their money on co1nmissions but on the difference in the bid/ ask spread (the price at which they sell and the price at which they buy).

INTERBANK MARKET

The greatest share of forex trading takes place in the interbank market in the form of currency swaps, forwards, and other sophisticated trans­actions. The interbank market is a global over-the-counter network that includes, as its name suggests, the world’s largest banks as its backbone along with other large financial instituions and corporations that have to be members of the network to paiticipate.

There  is no centralized market place in the interbank market, no standardized contracts, and no central regulator. Transactions are conducted between parties over the phone or electronically. Based on a call-around tradition, deals may involve billions of dollars as price, delivery, and other term s are negotiated, sometimes on behalf of cus­ ton1ers but often for bank s or institutions as they speculate on the price movement of currencies.

However, unless you are a corporate treasurer, a global money man­ager, or someone in a similai· position, the interbank market is prob­ably not something with which you will be involved. This is a complex mark et reserved for sophisticated, professional, and nimble traders. There are, however, places where traders have easy access to the same type of forex trading that the big boys have in the interbank market.

 

FOREX FUTURES TRADING

Although futures contracts generally came along somewhat later than well-entrenched cash markets, the opposite is true with forex futures. Chicago Mercantile Exchange (CME) introduced futures on currencies in May 1972, not long after President Nixon closed the gold window and before many currencies had achieved free-floating status. Forex futures have traded in a floor setting with trading limited to regular trading hours during the day for more than twenty-five years.

When CME launched its Globex electronic trading platform in 1992, electronic trading was limited to after-hours or overnight trading outside of the floor-trading hours. Then CME moved to side-by-side trading several years ago, allowing electronic trading almost around­ the-clock, including during those hours when trading was taking place on the floor.

Volume has been booming since then to make CME’s currency market the world’s largest regulated marketplace for forex trading. In 2004 CME traded more than 50 million forex contracts, a 50 per­cent increase from the previous year, with two-thirds of those contracts  traded electronically. With CME making a major push to encourage trading in options on forex futures, forex volume is likely to get much larger at CME in the future.

In addition to the major forex pairs and a dozen other currencies offered at CME, Eurex has moved into forex futures tratting and the New York Board of Trade trades U.S. Dollar Index (USDX) futures. The USDX is not a currency, per se, but it does provide a good gauge of the value of the dollar against a basket of major currencies although trading in the USDX contract is not as active as trading in the major currency pairs

Forex futures do have a few different quoting conventions than ,what traders will find in the interbank and cash forex markets. For example, the familiar quote for Japanese yen in the cash market is in the number of yen per dollar so traders will hear a USD/JPY quote of, say, 110 yen.

In the futures markets at CME, prices are quoted in the value of the currency as it relates to the U.S. dollar for example, yen at 110 in the cash market would be 0.009091 in futures lingo (0.9 of a penny), often quoted as ju st 9091.

In addition to the benefits of cash forex trading mentioned earlier, futures exchanges provide some other advantages that may encourage trading forex futures.

One Central Market

Instead of having just one source pro­viding bid/ask quotes as in cash forex trading a source that incidentally knows your position there are literally hundreds of traders, inclutling major banks and financial institutions, mak ing bids and offers all the time in futures. All of these bids and offers are channeled into one place, leading to the establishment of one pri ce that is widely distributed the instant  a trade takes place.

Tight Bid/Ask Spreads

With so many traders and so many bids and asks all coming into one location at one time, futures provide substantial liquidity and a smooth flow of trading from one price to another. The spread between bids and asks is small in forex futures, frequently only a pip or two, in a very competitive environment. Traders cannot count on that when they deal with only one furn fac­ ing no competition when it comes time to close out their position.

Transparent Pricing 

The current price determined by these multiple sources is available to all traders of all sizes at the same time. Electronic futures trading does not play favorites bu t puts the small trader on an equal footing with the large trader on a level playing field. Traders are not limited to one set of bid/ask quotes offered by one firm and do not have to worry that prices may favor a dealer who may be factoring hidden spread costs into its quotes. All prices and all costs associated  with forex futures trading are out  in the open.

No Counter-party Risk

Traders do not trade with one firm and do not have to worry about the creditworthiness of the party that may be on the other side of the trade. In futures trading, the exchange’s clearing orga­nization is actually the counter-party to every trade, setting rules and policies to preserve the integrity of futures markets and provide a verified record of all trading activity that can  be audited, if necessary.To date, no trader  has ever lost  money in futures due to counter-patty default.