The above features may significantly impact your trading results.
Regulatory Oversight
The NFA (National Futures Association) presently has limited regulation over the spot Forex market .
Indeed, the spot Forex market is one of the least regulated
markets in the world. This gives spot Forex broker-dealers opportunities to manipulate their
price feeds without any legal constraints. Indeed, spot Forex broker-dealers even have the legal right
to revoke trades in your account for whatever reason they deem necessary. With limited
regulatory oversight, the individual trader has very few legal options in case a problem arises.
Gradually over time, more regulation over the spot Forex market is expected.
On the other hand, the futures Forex market is already
heavily regulated by the NFA (National Futures Association) and the CFTC (Commodities
Futures Trading Association). Moreover, the CME (Chicago Mercantile Exchange), where
Forex futures contracts are traded, is a publically traded corporation, and is thus
regulated by the SEC (Securities Exchange Commission) as well. The highly regulated
nature of the market maximizes transparency and fairness in all trading operations.
Moreover, a well-defined system of arbitration exists to handle legal disputes. Brokerages,
clearing firms, brokers, Commodity Trading Advisors, and Commodity Pool Operators
must be registered with the NFA and held accountable to the highest standards of conduct.
The NFA web-site includes a public
record of the complete history of registrations, citations, and legal actions of members
in the futures industry.
Central Exchange
The spot Forex market has no central exchange, so prices may vary from broker-dealer
to broker-dealer. Each broker-dealer is a market maker and has the right to set the
currency exchange rate at whatever price it deems fit. That is, the broker-dealer is
making the markets which its clients are trading.
On the other hand, the futures Forex market is one, centralized market, where all trading
occurs at the CME (Chicago Mercantile Exchange). Thus, prices are uniform throughout the
world for all traders, and true volume data is available. Consequently, major banks and
financial institutions use the futures Forex market at the CME to hedge their currency risks.
Market Maker
It is important to note that the individual spot Forex trader does not actually trade the spot Forex interbank market.
Rather, they trade the markets which the spot Forex broker-dealer makes.
Spot Forex broker-dealers are market makers, that is, they create the markets which
their clients trade, and they may take the other side of their clients trades. This can create
a conflict of interest. Manipulating prices and revoking trades are some of the
tools of a market maker, and clients have no legal recourse when such actions
negatively affect their trades.
Recently, some spot Forex brokers have begun to offer trading via the ECN (Electronic Communications Network) model.
According to the advertisements, trading via an ECN broker is more advantageous to the client, because
client orders are routed to a best-bid/best-offer system involving multiple banks.
However, it is important to keep in mind that the counterparty of client orders in an ECN model is
simply shifted from the dealing desks of the brokers to the dealing desks of the banks which are setting
the bid/ask spreads. Thus, a potential conflict of interest still exists, since the banks are acting as
market makers. Moreover, ECN trading typically requires more initial capital, an extra commission fee for the broker,
and the bid/ask spreads may vary greatly depending on market volatility.
On the other hand, the futures Forex is traded in the pit at the CME, as well as electronically
via the Globex system. The Globex system is an electronic matching system, which directly
matches buyers and sellers in the market. (Like NASDAQ for stocks.) The role of the futures broker
is merely to facilitate trading between buyers and sellers, but the futures broker does not take the
other side of its clients' trades. Only true buyers and sellers in the market participate, leading to
the most fair, open, and transparent market as possible.
Clearing Firm Regulation
There is no regulation over how money deposited with a spot Forex broker-dealer is handled.
Different spot Forex broker-dealers have different policies. Some mix clients money with
their own operational funds. This may lead to mishandling of clients' funds, and if the
broker-dealer goes out of business, the clients' funds may be lost.
On the other hand, the NFA requires that all clients' futures funds must be held by
registered clearing firms in customer-segregated accounts.
(“Customer-segregated” means that your money is kept completely separate from the
clearing firm's own operational accounts.)
Our clearing firm is R. J. O'Brien, founded in 1914, one of the oldest and most respected
Futures Commission Merchants (FCMs) in the industry, with nearly $3 billion under management.
At R. J. O’Brien, your money is kept in customer-segregated accounts
at Harris Bank, a member of the Federal Deposit Insurance Corporation (FDIC).
However, it should be noted that even though client funds are required to be
segregated, there is still the possibility that clients can still
lose all of their funds on deposit with the FCM.
The recent bankruptcy of Refco is a case in point, where Refco's spot Forex clients
lost a significant portion of their deposits, while Refco's futures Forex clients were
fully refunded.
Commissions
Spot Forex trading is often advertised as "no-commissions" trading. However,
the commissions is actually hidden in the bid/ask spread. Moreover, during certain market times,
for example, when volatility increases, spot Forex broker-dealers may considerably widen the bid/ask
spread, effectively costing the trader a significant amount of money to enter the trade.
On the other hand, commission rates for futures Forex trading are clearly stated up-front,
and the highly competitive nature of the industry keeps rates as low as possible, especially
for self-directed, independent traders. And, full-service products, such as research, advice,
and managed trading are also available for clients who want more direct help with making
trading decisions from a licensed broker.
Leverage
Very high leverage is offered in spot Forex trading, 100:1, 200:1, and even 400:1.
For example, using 100:1 leverage, $100 is multiplied by 100 to effectively yield $100,000
worth of buying power. Thus, you can open a spot Forex trading account for a relatively
small amount of money. High leverage works in your favor when your trade is winning,
but it works against you when your trade is losing. As the saying goes, the more leverage,
the more rope with which to hang yourself (when you're losing).
Used conservatively, high leverage also makes it possible to substantially limit your risk,
as many spot Forex brokers offer mini (and even micro) accounts.
On the other hand, leverage for futures Forex trading is generally less than 50:1
(true for other futures contracts in general).
For example, a Euro futures contract is worth approximately $170,000 USD, but it
requires approximately $6,000 margin to trade the contract, so the leverage in this example is
approximately 30:1. Because of the lower leverage, opening a futures Forex account
typically requires more capital than a spot Forex account.
Contract Volume Data
Because there is no centralized exchange for the spot Forex market,
there is no way to collect or report total trading volume information.
If a "volume" is reported, it pertains specifically to the broker-dealer's own client-base,
not the entire market as a whole. Moreover, the reported "volume" is tick-volume
(total number of changes in bid/ask), not contract-volume (total number of lots traded).
On the other hand, because futures Forex is traded through the CME,
total contract volume and open-interest data are available. Such volume information is
an essential part of certain trading methodologies.
Market Times
The spot Forex market is open 24 hours from Sunday evening to Friday afternoon in
the U.S. However, during only certain hours of each day is the market very active.
The Globex system for the futures Forex market is open 23 hours a day, with a break
between 4 PM and 5 PM each weekday, and shortened hours on Sunday and Friday sessions.
Again, during only certain hours of each day is the market very active.
Conclusions
The spot Forex and futures Forex markets offer traders both the potential for profit,
as well as the risk of substantial loss. As discussed above, there are significant differences
between the two kinds of markets. The main advantage of the spot Forex market is the high
margin it offers, allowing traders to open accounts with just a few hundred dollars and limit
their risk to pennies per trade. The main disadvantage of the spot Forex market is the
relative lack of transparency in prices, since the dealing desk of the broker
(or banker in the ECN model) is the market maker taking the other side of your trade.
On the other hand, the main advantage of the futures Forex market is its highly regulated
nature, where speculators and hedgers can trade in as transparent and fair market as possible.
The main disadvantage of the futures Forex market is the relatively lower margins it offers,
resulting in higher capital requirements to trade and higher monetary value per tick in price
movement.
