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Forex Forward contracts

If you have ever traded commodities futures or put and call options in the stock market, you will already have a basic understanding of how forward contracts work in the FOREX markets. If you haven’t used these financial instruments, don’t worry because this article aims to explain them.

Forward contracts are instruments that lock in a future price for a currency. The idea is that you can purchase or sell a foreign currency on a certain future date at a certain price.


For example, let’s say you are doing business in Japan. You are going to purchase electronic parts from some companies in one year. The value of those electronic parts is denominated in Yen. You know that if you can purchase those parts at today’s prices, you will be able to produce your product for a profit. However, the price of the Yen could increase substantially if your native currency drops over the course of the next year. In this case, in order to assure a stable price for those Yen you will need one year from today, you can purchase a forward contract. The contract will lock in those Yen, at say 100 per dollar. Thus if in one year’s time the Yen is at 98 per dollar, you will still be able to purchase them at 100 per dollar because the rate has been locked in.

Thus, forward contracts are can be crucial to having successful international business transactions. They can guarantee the costs of imported goods in your local currency, no matter what happens in the Forex markets. There is a potential danger however. If the dollar rises in strength, and you can purchase 110 or more Yen per dollar after the year has run out, you are still obligated to complete the contract. In this case, your decision to engage in the forward contract would have been disadvantageous because the Yen is now cheaper. Of course, the stability of the transaction was guaranteed over the course of the year.

Forward contracts are also used by currency speculators who expect a currency to rise or fall in relation to their native currency. If they can lock in a rate for the purchase of a foreign currency now, and that currency rises in value over the course of the year, they can reap a profit of the difference between the currency. Much like commodity futures or stock options, the idea is to set a price for a future transaction today.

The prices of forward contracts are determined by two elements. The first is the spot price, or the current price of the currency involved. The second element is the interest rate differential. If one currency is currently receiving a higher interest rate from its central bank than the other currency, this difference needs to be taken into account when determining the price of the forward contract.

Forward contracts can generally be arranged by speaking with representatives from your bank. Generally banks will handle the details required and will set up a forward contract to meet your needs.

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Asides

  • Wondering if online forex trading is genuine? The answer is yes, online forex trading is genuine. However, not all forex brokers are reputable. Online forex brokers who operate dealing desk operations should usually be avoided as they are believed to make their money by trading against you so you are pretty much guaranteed to lose your money. Look for brokers who run no dealing desk operations or a forex Electronic Communications Network otherwise known as an ECN.  The reason more everyday individual forex traders use a retail forex broker instead of trading via an ECN which is regarded the most ideal way to trade forex online, is that retail brokers usually have smaller minimum balances and many new traders can only afford a small initial deposit.

  • If you are new to forex trading and wondering what is a forex trading account and how to get one, a forex trading account is an account that you apply for with an online retail forex broker. Your account allows you to trade forex online at any time of day or night from Sunday at 5:00PM EST to Friday at 4:00PM EST.

    You will usually have to fill out an application and submit evidence of your identification to obtain an account with any reputable forex broker. Your application will be reviewed and once accepted you will then have to fund your account in order to begin trading forex. Different brokers have different limits on the amount that you need in order to establish a live account forex trading.

  • FX is just another term for forex and fx online trading refers to forex trading conducted via the Internet. The Internet has made forex trading accessible to the masses. Once upon a time  the fx trading market was restricted to participants trading on the interbank level and other well-financed players. Today, every day indivuduals are trading forex via one or another online forex trading platform thanks to the services provided by retail forex brokers.

  • Day Trading is an investing term. It refers to the act of buying and selling financial instruments within the same trading day, which means your trade does not carry over into another trading day. You open and close positions all in the same trading day.

    Forex is a short form of foreign exchange and foreign exchange refers to the financial market wherein currencies are exchanged or traded.

    Currency when referenced in the context of day trading forex refers to the money of one country that gets exchanged or traded for the money of another country.

  • Don’t expect to be able to predict what’s going to happen in the forex market. The forex market is unpredictable. Just when you think you have the market figured out, it does the exact opposite of what you expect it to do based on your previously drawn conclusions.

  • When you consider that even professional forex traders lose money it should give you a good enough idea that forex trading is not Math or Science. There isn’t a formula that  will yield profit 100% of the time like adding 1 + 1 must yield 2 100% of the time.

  • Some forex analysts recently forecast that that euro would be trading at 1.45 USD within a few months and if things continue on their current path these analysts will have projected accurately. The EURUSD rate is currently fluctuating between a day low of 1.4697 and a day high of 1.4828 August 13th, 2008.

  • The US dollar is starting to let up a bit, and analysts expect the majors to do some climbing back after dropping significantly against the USD over the last couple of weeks; however the expectation is for the majors to drop again.

    Get some trading ideas from expert strategists who are following the USD currency trading drama.
    Forex Market Prepares For Dollar Strength Correction

  • FXCM Trading Station II is probably one of the best forex trading platforms out there for novice traders. It’s fairly easy to use. In fact it’s such a nice system even Deutsche Bank uses it with their DBFX trading station. But in the case of FXCM don’t expect the trading station to behave exactly the same in live mode as in demo mode. There is definitely a difference even though you can’t see the difference structually. Even FXCM admitted the live mode and demo mode aren’t exactly the same. They look the same but your trading experience while in demo mode will be a lot more profitable than while in live mode. That should make you wonder. They say it’s the slippage and volatility but in demo mode you’re almost always profiting. In live mode almost always losing….

  • The truth is you probably won’t get rich trading forex. Successful forex traders understand the foreign exchange market and currency trading on a level that is not understood by the average retail forex trader. If you don’t actually understand the fundamentals or even the technicals for that matter you’re going to find it’s a lot more difficult to make a profit from your fx trading account; but even though it will be difficult it’s not impossible. You probably won’t join the forex millionaires club,  but you can still make decent money.

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