Forex and futures trading in the UK have vital differences that traders must consider before deciding which to trade. These include the type of contract, the underlying asset, and the regulatory framework.
Futures contracts are traded on exchanges, while forex contracts are traded OTC (Over the Counter). Futures contracts are also standardised, while traders can customise forex contracts to the trader’s needs.
The underlying asset for futures contracts is usually a commodity, such as gold or oil, while the underlying asset for forex contracts can be any currency pair. The regulatory framework for futures trading in the UK is provided by the Financial Conduct Authority (FCA), while the Bank of England provides the regulatory framework for forex trading.
The distinctions between forex and futures trading
There are a few significant distinctions between forex and futures trading that everyone should be aware of when it comes to trading. Here we will outline the main distinctions between the two types of trading so that you can make an informed financial decision about which is right for you.
Currency Pairs
When you trade forex, you are buying and selling currency pairs. For example, if you buy EUR/USD, you are buying Euros and selling US Dollars. When trading futures, on the other hand, you are speculating on the future price of a commodity or index. There is no physical exchange of currencies taking place.
Leverage
Forex trading offers significantly more leverage than futures trading, which means you can control a more significant position with less money. However, it also means that any potential losses are magnified. For example, if you trade with 100:1 leverage and the price moves against you by 1%, you will lose all of your money.
Margin
When you trade forex, you only need to put down a small percentage of the total value of the trade as a margin because forex pairs are traded in lots, and each lot is worth $100,000. So, if you want to buy one lot of EUR/USD with 100:1 leverage, you would only need to put down $1,000 as a margin. On the other hand, futures contracts are traded on margin, which means you have to put down a more significant percentage of the total value of the trade upfront.
Volatility
Forex pairs tend to be much less volatile than futures contracts because currency prices are affected by various factors, such as economic data releases, central bank policy, and global events. On the other hand, futures contracts are influenced mainly by supply and demand for the underlying commodity or index.
Liquidity
Forex pairs are the most liquid instruments in the world, which means someone is always willing to buy or sell at the current market price. Futures contracts can be less liquid, depending on the underlying asset. For example, Contracts for Difference (CFDs) on individual stocks are often less liquid than major stock indices.
Cost
Forex trading is typically commission-free. You will only pay the spread, the difference between the bid and the asking price. Futures trading can be commission-free, but you may also have to pay fees such as exchange, platform, and data fees.
Risk
Both forex and futures trading come with risks. However, the risks are different. When trading forex, the most significant risk is that of currency fluctuations. For example, if you buy EUR/USD and the Euro weakens against the US Dollar, you will make a loss. Futures trading is risky because you are speculating on the future price of an asset. If the price moves against you, you will make a loss.
Summary
These are some of the critical distinctions between forex and futures trading. You need to consider your goals, risk tolerance, and capital requirements when deciding which one to trade. Forex trading may be suitable for you if you want to speculate on the short-term movements of currencies. However, futures contracts may be a better option if you are looking to hedge your portfolio or trade a specific commodity.