This week I had the pleasure of teaching the Professional Trader class at our Philadelphia campus, welcoming another group of fantastic students to Online Trading Academy and our core strategy of recognizing true supply and demand in any marketplace. The Professional Trader class focuses on executing live trades with real money in the Equities market, but we also show the class the power of understanding how trading multiple asset classes can help to give the astute trader an edge over others.
One of the most common questions I get during the class, is usually about trading Forex and which is the best way to do it. As you may or may not know, currency markets can be traded in five different ways: Spot FX, Currency Futures, Forwards, ETFs and Options. It should be known that of all these ways, Spot FX and Futures account for pretty much a third of all currency volume traded worldwide and are without doubt the perfect choice for the active trader. So why would we choose one over the other and how are they different if they are both a way to trade the same thing?
Spot FX is always made up of pairing two currencies together like the EURUSD, because the only true way we can place a value on a currency is by comparing it against another currency, hence why we trade them in pairs. The spot market is a de-centralized market based on the rates which the largest banks in the world trade currency rates at. Worldwide FX dealers will take these exchange rate prices, widen the spread (the difference between the Bid price and the Ask price) and then provide a market for retail traders to execute their positions in line with the market actually trading the banks. This spread can widen at any given time and with some brokers it is fixed for most of the time and with others it can widen and narrow with changing market conditions as the day moves along. Generally however, the spreads do tend to be competitive among dealers as they are all competing for your business and this requires a relatively cheap cost of doing business for the client. On say EURUSD, one could expect a spread anywhere from 2-3 pips during liquid market hours. The choice of pairs to trade is also extensive and it requires very little money to open an account and get trading.
Currency Futures offer the equivalent asset classes to spot FX however the liquidity is only present in the US Dollar based parings, like EURUSD, AUDUSD and GBPUSD. You can trade the futures version of say the CADJPY spot pair but the volume on a daily basis is next to zero, so getting in and getting out of a trade may be an issue. Trading the futures version on the EURUSD would be carried out by trading the EC Contract which is priced in US Dollars and is based on contract value of 125,000 Euros, thus the price of the near contract matches the EURUSD spot price and even the chart is practically identical.
However, to open a futures account requires more money and the smallest size you could trade on the EC contract is $12.50 per pip, so it’s not for the absolute beginner by any means. Yet for the more seasoned and well educated trader, the currency futures offer the unique benefits of being traded through an actual exchange (the Chicago Mercantile Exchange), lightning execution and my personal favorite, the ability to buy at the bid price and sell at the ask price with limit orders, eliminating the spread altogether. This lack of spread offers us a huge advantage when intraday trading because it not only keeps our costs of doing business down but also means that if you are able to time the market with precision, you can get away with some incredibly tight stops, allowing you to seek great risk to reward ratios on a daily basis. If I was to tell the average spot FX trader that you could get away with an 8 pip stop on the EURUSD, they would find it hard to believe but this is very much possible when you trade the currency futures and don’t have to pay a spread, especially if you have also been educated on how to find the areas of supply and demand where institutions are buying and selling. Let’s look at a trade I took before class last week on the Euro Futures as an example:
The trade was an entry short at 1.3109 and an 8 pip stop above at 1.3117, with a 3:1 target 24 pips below. The reason for the short was due to the imbalance created at the Supply zone with more willing sellers than willing buyers, thus offering a high probability, low risk trading opportunity. While an 8 pip stop may seem tight to some the fear of being taken out of the trade because my stop was too tight never enters my head as I always choose logic over anything else. You see it does not matter how volatile or quickly the markets move, they have to stop rising or falling when they hit a stack of latent institutional order inventory.
Think about it for a second, how can prices keep rising if they hit a level where there are more orders to sell that there are to buy and how can prices keep falling if they hit a level where there are more orders to buy than there are to sell? The answer is that they can’t. When Supply is greater than Demand prices must fall and when Demand is greater than Supply, prices must rally, nothing more nothing less. Therefore if a trader knows how to spot where these huge orders are on a price chart then using the futures market to take trading opportunities with tight stops and high rewards is very much possible. You just need to know what you are looking for. Take out the spread on the Spot FX and gain the ability to buy and sell short without paying a spread and you have yourself a very cost effective way to trade the currency markets that you may or may not have been aware of up until now. Maybe it’s time for you to consider the Futures…
Have a great week and take care,