Forex Trading System- Forex versus Futures

OVERVIEW

In our original Currency Trader’s Companion: A Visual Approach to Technical Analysisof Forex Markets(2004) in the chapter entitled “Spot Currency Prices versus CurrencyFutures,” we presented two tables that rank currency futures in order of their futurestrading volume. A complete list of all commodity futures is published monthly by Active
Tradermagazine, which we again gratefully acknowledge. That chapter was included sim-
ply to give the reader an idea of the magnitude of volume and open interest in the com-
modities market since these figures are not currently available in forex spot markets.

PIP DIFFERENTIAL CHART

In this current book, we prefer to go one step farther and compare spot prices with fu-tures prices graphically over the same time frame. For this purpose, we have createdthe pip differential chart, which compares a spot currency pair with the analogous fu-tures currency pair.

Figures 4.1 and 4.2 are the charts for the EURUSD and the GBPUSD currency pairs.In both cases, the spot currency prices are displayed in the upper third of the chart. Inthe center is displayed the corresponding futures currency. In the lower section of thechart is displayed the pip differential oscillator, derived as shown in Figure 4.3.

First, the explanation of the Chicago Mercantile Exchange (CME) ticker symbols is:

ECM4 = Eurocurrency June 2004
BPM4 = British Pound June 2004

where June 2004 is the expiration (or delivery) month.

Our first observation is that the spot data has a greater daily range than the futuresdata, which we attribute to its greater trading activity. Also, futures contracts are usu-ally thin markets during their infancy and grow more liquid as they mature, the result ofincreased volume and open interest.

Interesting to note is that in Figure 4.1 the price differential oscillates on both sidesof a zero mean, while in the Figure 4.2 the spot price is almost always higher than the fu-tures price. This anomaly can probably be explained, though with some tedious re-search, by the changes in short-term interest rates between the three currenciesinvolved (USD, EUR, and GBP). Veteran commodity traders will probably recognize thisphenomenon as a variation of so-called backwardization.

Also, the fact that the pip differential chart for EURUSD/ECM4 does in fact undu-late around a zero mean brings up an important point. There may be a very profitableleader/lagger relationship between the two financial vehicles if a discernible pattern canbe uncovered.

ACTIVITY VERSUS VOLUME AND OPEN INTEREST

In Figures 4.4 and 4.5, the upper section displays the daily activity of the forex currencypair. The volume and open interest of the currency futures contract are displayed in themiddle and bottom sections respectively.

CONCLUSION

This chapter offers only a preliminary visual comparison between forex activity and fu-tures volume/open interest. An exhaustive study between spot and futures currenciesthat includes multiple delivery months and cross correlations, both historical and re-cent, is obviously an important weapon in the active currency trader’s arsenal.