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1.1

Why Do We Analyze Futures Instead of Forex?

Starting with the Bretton Woods currency system (1944), the US dollar has been the main international reserve currency, so the quotes of other countries’ currencies are expressed through the US dollar.

Types of currency quotes:

– Direct quote (fixed amounts of the foreign currency are expressed as variable amounts of the domestic currency)

Example (US dollar is not the domestic currency): USD/CAD 1.3090 means 1 USD = 1.3090 CAD

– Indirect quote (fixed amounts of the domestic currency are expressed as variable amounts of the foreign currency)

Example (US dollar is not the domestic currency): EUR/USD 1.0680 means 1 EUR = 1.0680 USD

– Cross quote (the ratio between the two currencies, which is determined based on the rates of these currencies relative to a third currency)

Example: EUR/USD 1.0680, GBP/USD 1.2470 means EUR/GBP 0.8565 (1.0680/1.2470)

Based on the location of performing currency transactions, there is an exchange market and over-the-counter market.

Table 1. Comparison of exchange and over-the-counter market

Unlike exchange market, in the over-the-counter market there is no central marketplace (the exchange clearing house), where all information about the transactions, on the prices reached by the parties, is received. In addition, there is nobody that would control and regulate the activities of all participants in the trading process. Therefore, different exchange dealers may have different quotes of the same traded instrument (such as a currency). Nevertheless, the prices from exchange trades, on the relevant basic commodities for the nearest most liquid futures contracts, are used for the formation of over-the-counter quotes (WM/Reuters benchmark rates are used as standard rates for determining the OTC exchange rate).

Since Forex market is an over-the-counter market, and the transactions made in it (demand and supply) cannot influence the change in quotes, futures on the relevant currencies should be used for analysis and forecasting.

Table 2. The most liquid CME currency futures contracts as of 01.02.2017 and the corresponding Forex currency pairs. Types of Quotes – US dollar is not the domestic currency. Volume data source: cmegroup.com

Charts of Forex direct quotes are a mirror image of the relevant CME futures charts. Charts of Forex cross quotes (Examples: AUD/CAD; AUD/JPY; CAD/JPY; EUR/AUD; EUR/CAD; EUR/GBP; EUR/JPY; GBP/AUD; GBP/CAD; GBP/JPY) are the mathematical relationships of direct and indirect quotes, therefore, those who trade cross quotes are Lucky-traders.