As a full time forex trader myself, I am constantly amazed at the number of emails and questions I receive from traders who have started trading in the currency markets, and have subsequently lost all their trading capital, either because they had no trading strategy whatsoever, or because they failed to protect their positions with solid risk management or by hedging in other markets. Currency trading is like any other – it takes practice, effort and time to learn how to make money. However, one of the biggest advantages of currencies is that much like commodities, they trend strongly, and once a trend starts, then this will tend to run for weeks or months before reversing, and is therefore ideal for longer term trading, and not short term scalping. Many novice forex traders scalp from day one, failing to realise that there is far less stressful and more profitable way to trade using the long term trend. Let the trend be your friend is an over worked saying, but in the currency and commodity markets it is perfectly valid, and if you follow this maxim in developing your trading strategy, you won’t go far wrong.
As such, one of the perfect trading strategies is to use currency futures as a hedging mechanism to hedge a position in the spot fx market, but there are various aspects of this trading strategy that require careful attention before entering any trades as their are several differences between the two markets, and any hedged position must be balanced between the various contract sizes. The first difference you will find in a currency future is that this is often quoted in a different format to that in the spot market, for the simple reason that currency futures are often quoted against a base currency of the US dollar, and therefore as such, some currency pairs such as the euro dollar which is quoted in the spot market as the EUR/USD, may be quoted as the USD/EUR on the currency futures exchange. Many exchanges are now changing their quote format so that it aligns with the convention in the spot fx market, making life easier for retail traders as a result. The second and more important aspect is of course the contract size, and as with dow jones futures and commodity futures, you need to establish this from the start to make sure your hedging trade is balanced correctly, and below you will find a copy of the euro dollar contract from the CME.
As you can see from the above contract from the CME exchange the eur/usd currency futures contract specifies an underlying contract size of 125,000 euros, which means that to hedge a spot market contract, then this must be matched to this size, and this can be a problem particularly where the contract size does not convert easily. In this case, the closest we could get to one currency futures contract of 125,000 euros would be to use 12 mini lots ( 120,000) or or full lot, ( 100,000) neither of which match exactly. We could of course use four currency futures and 5 full lots in the spot market to overcome this particular problem. The same problem exists for contracts with the GBP, which generally quotes a contract size of 62,500 against the US dollar, so here again we have a problem and the closest option is to use 6 mini lot contracts. Speaking of options, currency options are an alternative of course if you feel currency futures are a little cumbersome for you. However, despite some of the disadvantages outlined above I believe they offer and excellent and elegant solution to the problem of hedging in the fx spot market.
Finally, thank you so much for taking time to visit, and I hope that you find the previous pages both useful and informative and helpful in developing an understanding of the futures market in general, and dow jones futures in particular – kind regards Anna
