Futures Trading Vs OTC Forex & CFDs… FIGHT!

Futures Markets evolved in the 19th century to bring producers and consumers together. In the USA, exchanges opened in Chicago to service the needs of mid western farmers and food producers (these would evolve into the modern day CME and CBOT exchanges) whilst in the UK, the informal trading of metals that had existed for hundreds of years in the courtyard of and outside the Royal Exchange become formalised with the establishment of the LME or London Metal Exchange. The role of these exchanges was to provide a marketplace where producers and their customers could buy raw materials and food stuffs for delivery on a fixed date in the future. Trading was conducted using standardised contracts, which specified the quality or grade of the underlying and the amount that each contract or lot represented.

For the first time both producers and consumers could plan ahead and have a clear idea about budgets and revenues. Producers could forward sell their production and know in advance what their income would be. Whilst consumers / manufacturers could buy raw materials for future use at a known price, allowing them fix their costs in advance. These were essentially trade markets that serviced the needs of the associated industries and their infrastructure and practices were designed accordingly. That legacy remains in place today.

Wholesale markets

Standardising contracts, their delivery months and the terms under which they were traded helped to form orderly dependable markets, which met the needs of trade users. But by the same token these these rigid structures did not provide the flexibility that other potential users required. For example if an investor unconnected to the petroleum industry wanted to  speculate on the price of Crude oil they would have needed to first demonstrate that they were able to make or receive delivery of that Crude oil. The standard size of the Brent Crude contract traded on the London International Petroleum Exchange was for 1000 barrels of oil. Each of which comprises 159 litres, which amounts to an awful lot of oil. What’s more delivery of this contract had to made or accepted at a specific list of oil storage facilities. The same procedure is true for a large number of exchange traded futures contracts whether they are for livestock or copper.

Innovation brings benefits

However innovation was at hand in the shape of Contracts for Differences. These revolutionary instruments recognised that not every end user wanted or needed delivery of the underlying. Rather they were only interested in the economic difference (profit and loss) between the points at which they bought and sold a contract. These new CFDs were settled for cash on that basis and therefore did away with the need to have delivery arrangements in place – they democratised the financial markets overnight.

Widespread change

For many years Foreign Exchange trading was also a commoditised and deliverable business, which principally serviced the needs of global commerce, large international investors and the private banks of the world’s super rich. Counter-parties to a trade had to make or receive delivery of the underlying. Such that if you sold GBP 10 million to buy USD at $1.50 then you would have to deliver your GBP 10 million to the buyer, in two days time, and in return take delivery of your USD 15 million, albeit electronically.

It soon became clear that it would be possible to trade Forex using CFDs, that is without delivery and with net settlement between the opening and closing prices. Furthermore it also became clear that these contracts could be traded on a margin basis. Via an initial margin or deposit, a running P&L (profit and loss) and variation margin, as when and if required. When this flexibility was paired with the internet and the ability for users to interact directly with the markets a trading revolution was quite literally born.

Specialist brokers

Foreign Exchange has always been an OTC or Over The Counter market without any central exchange or marketplace, rather counterparties have always traded amongst themselves in a hierarchical structure, initially by phone and in more recent times electronically.

Brokers such as Blackwell Global were formed to act as an intermediary between smaller institutional and retail clients and the $5 trillion dollar a day Forex market. Brokers leveraged their clients accounts allowing them to control larger positions than they would otherwise be able to afford. But they also offered their clients the opportunity to trade in fractions of a lot. The standard lot size in Forex for example being 100,000 units of currencies, such as US Dollars, Euros, Pounds Sterling etc. However clients of Blackwell Global can trade from sizes as small as 0.01 (that is one one hundredth) of a lot.

Trading Long or Short  

Another advantage of trading Forex in a non deliverable cash settled format was that clients could trade long (buy to open) and short (sell to open) with equal ease. That is if they wanted to sell the Yen, the Aussie Dollar or Norwegian Krone. Then they could do so without any need for pre existing ownership of those underlying currencies.

When this flexibility was combined with leverage a really powerful trading tool emerged. For example clients of Blackwell Global can leverage their deposits up to 400:1 subject to certain limits see our Trading Accounts page for full details.

This means that to open a position of $100,000 (at 400:1 leverage) a client needs only an initial margin or deposit of $250.00. Exchange traded futures contracts also operate on a margin trading or leveraged basis. But as these contracts are for the most part traded on a wholesale basis, initial margin requirements and minimum trade sizes are often likely to be higher. Whilst at the same time leverage ratios may be lower than that for the equivalent OTC contracts.

Direct Market Access and other factors

There were further innovations that helped to popularise OTC Forex & CFD trading. Foremost amongst these was the ability for clients to interact directly with the market without the need to have a conversation with their broker first. This was made possible through the introduction of dedicated trading software, that was both intuitive to use and specifically designed with the retail customer in mind. Unlike many exchange traded dealing systems which have often been built to meet the needs of professional and wholesale customers.

Our own Blackwell Trader MT4 is an example of this dedicated trading software. This  sophisticated platform comes complete with live prices, high quality charting functionality and more. It is available to our clients free of charge, via a simple download and installation process in conjunction with an account application. What’s more the platform can be used on desktop PCs as well as Android and iOS phones and tablets. This means that users can trade and monitor the markets seamlessly, across their devices,from wherever they have an online connection. Allowing them to take full advantage of the 24 hour a day 5 day a week Forex market.

Summary

To summarise then Futures Trading evolved to meet the needs of wholesale producers and  consumers. The establishment of formal market places or exchanges and standardised contracts allowed the two groups to trade freely with each other, in a way that had not been possible before. These exchanges and the contracts traded on them largely remain the preserve of those wholesale customers. Exchange practises and contract sizes often reflect that.

The introduction of non deliverable cash settled, margin contracts or CFDs allowed many more participants to access the markets. Specialist brokers (such as Blackwell Global) were established and offered their clients leverage and smaller trade sizes, alongside dedicated trading software. Thus creating a bridge between the wholesale markets and the retail investor. Retail investors wholeheartedly embraced this trading flexibility, which in turn created further demand for margin trading and helped spur growth in overall Forex volumes.

See for yourself

To see the benefits offered by OTC Forex & CFD trading for yourself why not open one of our demo trading accounts  then download our CFD & Forex Trading platform you will then be able to trade a highly realistic simulation of the real markets and when you are ready you can choose to open a live trading account  , make a deposit and trade the market proper.