Many traders are familiar with the EURUSD currency pair that trades within the spot or cash foreign-exchange market. Fewer traders are familiar with the Euro FX contract, which is traded within the context of the futures markets. Both of these instruments have similarities, however, there are some distinct differences that currency traders should be aware of. In this lesson, will be diving deep into all aspects of the Euro Fx futures contract.
Introduction to Currency Futures
Currency futures are financial contracts wherein the underlying asset is a foreign exchange rate. A few examples of currency futures include the British Pound to US dollar exchange rate, the Japanese Yen to US dollar exchange rate, and the Euro currency to US dollar exchange rate. One of the primary differences between trading currencies within the spot forex market versus the currency futures market is that within the spot forex market, trading is decentralized, and execution usually occurs through dealing desk brokers.
On the other hand, within the currency futures market, trading is centralized through an exchange, and trade execution occurs through these exchanges. An example of an exchange within the currency futures market is the Chicago Mercantile Exchange. Because of the presence of an exchange intermediary, the currency futures market tends to be much more transparent than the spot Forex market.
Unlike the spot Forex market, where brokers often offer varying lot sizes such as micro lots, mini lots, and standard lots, those trading within the currency futures realm will need to trade a minimum of one contract. This may not be feasible for some traders, particularly lower capitalized traders. To get a sense of the size of a standard one contract, let’s take an example of the Eur futures contract.
One standard contract for the Euro Fx futures contract represents €125,000. Let’s assume that the exchange sets the margin requirement for the Euro Fx futures contract at $2500. This is the minimum that you would have to post with your broker as margin to control and trade one standard CME Euro futures contract. Essentially, this would allow you approximately 50 to 1 leverage using the minimum required margin.
Within the context of the spot Forex market, the minimum price move is referred to as a PIP. In the futures market however, the minimum price move is referred to as a tick. It’s important to understand the different vocabulary and nuances between the two markets. Some traders prefer to take positions in the currency futures market because they value price transparency and a centralized trading exchange.
On the other hand, traders may prefer to take their positions in the spot Forex market, where they are able to scale in and out of trades much more efficiently, due to the lower incremental trading units offered. And so, there is no right or wrong answer. Each trader has to weigh the benefits and drawbacks within each of the two currency trading venues and decide which suits their purposes the best.
It’s also important to note that there are two different types of margin requirements as it applies to the futures markets. The first is what is known as day trading margin, which is often set by your futures broker. The second is referred to as overnight margin, and this is set by the trading exchange.
Day trading margin is often much less then overnight margin requirements. The downside is that you will only get the benefit of the lower day trading margins during the normal daytrading session. If you hold your position beyond a certain time, as set by the exchange, you’ll need to maintain the overnight margin requirement, or risk having your position liquidated automatically by a broker.
The five most widely traded currency futures instruments include the Euro to US Dollar currency future, the British Pound to US Dollar currency future, the Australian Dollar to US Dollar currency future, the Canadian Dollar to US Dollar currency future, the Swiss Franc to US Dollar currency future, and the Japanese Yen to US Dollar currency future. For our purposes here, we will focus our attention on the Euro to US Dollar currency futures.
Euro Fx Futures Basics
The Euro currency is the official currency of the Eurozone. The Eurozone consists of 19 nation states including Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain.
The Euro currency was brought into circulation in 1999. As of this writing, there is over €1 trillion in circulation across the world. The Euro Fx futures market provides traders the ability to profit from price fluctuations in the exchange rate between the Euro and the US dollar. The Euro Fx currency pair is the most liquid currency pair available to traders. And this is true within both the futures market, and the spot Forex market. The European Central Bank, commonly known as the ECB, is tasked with the responsibility of managing the Euro currency through monetary policy mechanisms.
The Euro Fx futures currency exchange rate is determined by the base currency in relation to the quoted currency. The exchange rate tells us how many US dollars, which represents the quoted currency, is required to purchase one euro, the base currency. In other words, this exchange rate reflects changes in the value of the US dollar against the value of the Euro currency.
The primary exchange for trading Euro Fx futures and Euro Fx currency options contracts is the Chicago Mercantile Exchange, or CME. Along with the standard Euro Fx contract which represents €125,000 as the notional value, the CME also offers a mini sized Euro Fx futures contract. This mini sized contract has a notional value of €62,500.
When analyzing the price chart for the Euro Fx pair, what we are trying to gauge is whether we expect the exchange rate of the Euro US Dollar to increase in value or decrease in value. If, we believe that the Euro will increase in value against the US dollar, we would place a long position in the Euro Fx contract. On the other hand, if we believe that the Euro will decrease in value against the US dollar, we will place a short position in the Euro Fx contract.
Let’s try to understand this from a practical sense. For example, if exchange rate for Euro Fx increases from 1.60 to 1.70, what that effectively means is that you would need $1.70 to purchase one Euro. And since this represents an increase from $1.60, we can see that this change in the exchange rate represents an increase in the value of the Euro against the Dollar, or said another way, a decrease in the value of the Dollar against the Euro.
Let’s look at another example but this time in reverse. If the exchange rate for the Euro Fx contract decreases from $1.70 to $1.60, what that tells us is that you would require $1.6 to purchase one Euro. Since this reflects a decrease from $1.70, we can understand this change in the exchange rate to reflect a decrease in the value of the Euro against the dollar, or said another way, an increase in the value of the Dollar against the Euro.
Euro Fx Futures Contact Specs
Let’s now discuss in more detail the CME Euro Fx futures contract specifications. Firstly, as we mentioned earlier, the standard contract size for the Euro Fx is €125,000. The Euro Fx futures contract trades on both the CME Globex and CME ClearPort platforms. The CME Globex platform is the one most retail traders will have access to. The trading hours for the CME Globex is Monday to Friday from 5 PM to 4 PM central time.
Euro Fx trades on the CME Globex under the symbol 6E. The minimum price fluctuation in the 6E instrument is measured in ticks. And that minimum tick is .00005 per Euro increment which represents $6.25 per contract. For those that use CME ClearPort, the symbol would EC. The Euro FX contract has a quarterly cycle which includes March, June, September, and December. And last but not least, the Euro Fx futures contract is settled via physical delivery.
Economic Reports That Influence Euro Fx Futures
So now that we have a basic understanding of the Euro Fx futures contract, let’s now discuss some of the economic news and data that have an influence on its price movement.
Central Bank Monetary Policy – Of all the different variables that contribute to the exchange rate of the Euro Fx futures contract, none is more important than central bank monetary policy. Within the United States, the Federal Reserve is responsible for monetary policy decisions. Similarly, within the Euro zone, the European Central Bank is tasked with monetary policymaking.
Any decisions made by these central banks can have a huge impact on the price of the exchange rate. And this is particularly true when it comes to interest rate decisions. Investors and traders keep a keen eye on what the Federal Reserve Chairman and ECB President say and do, as they can sometimes provide clues into future rate hikes or reductions.
Inflation Reports – Another class of fundamental data that is extremely important to monitor when evaluating the Euro Fx exchange rate are the relevant inflation reports such as the Consumer Price Index and Producer Price Index. Often inflation figures can have an impact on a central bank’s decision to raise or lower rates. For example, if the economy appears to be overheated and inflation is rising at a higher-than-expected rate, or the target rate set by a central bank, they may act to raise rates in order to maintain more normalized economic activity.
The most important inflation report is the Consumer Price Index. This report provides insights into the price of goods that an average household is likely to purchase. The primary figure to watch for within the CPI report is the core CPI. The core CPI calculates a basket of consumer goods but excludes the higher volatility energy and food sectors.
Gross Domestic Product – The gross domestic product, or GDP, measures the total economic output within an economy. In simple terms, it provides insights into the overall health and growth within a particular country or region. When the GDP is steadily rising quarter over quarter, or year-over-year, that is a sign of a healthy and vibrant economy. On the other hand, a steadily falling quarter over quarter, or year-over-year GDP figure would indicate a weakening or less than vibrant economic condition.
When analyzing Euro Fx futures, it’s important to review the GDP figures and the recent trends within those figures for both the Euro zone, and the United States to get a better sense of where the respective economies are headed, and how that data might provide insights into future price projections for the exchange rate.
Market Sentiment Studies – Another important class of studies that traders should analyze include sentiment studies. Sentiment studies can often provide an early clue into the level of confidence within an economy. As such sentiment studies are considered leading indicators rather than lagging indicators. Two of the more widely watched sentiment studies include the German ZEW survey, and the University of Michigan sentiment index.
Euro Fx Futures Analysis Using A Technical Approach
Another popular style of trading that is well-suited to the Euro Fx trading instrument is the use of technical analysis. Technical analysis is a broad subject and includes a wide array of methodologies. Some of these methods include candlestick analysis, pure price action analysis, market profile, classical chart patterns, harmonic pattern analysis, trend following, and much more.
It is beyond the scope of this article to dive into each of these different technical trading strategies. However, we will briefly look at a simple trend following system that can be used to trade the Euro Fx. Trend following systems tend to work well when the markets are displaying trending price behavior. And currencies are generally good candidates due to their frequent one-sided directional price movements.
The Euro FX trade strategy that we will discuss is based on just two indicators. The first is the Bollinger band indicator, and the second is a 200 period simple moving average indicator. The Bollinger band indicator will serve as our signal indicator, and the 200 simple moving average, or SMA, will serve as our trend filter. As such below are the rules for the simple trend following system for trading the 6E futures contract.
Let’s look at the long entry rules first:
Price must cross and close above the median line of the Bollinger band after having recently touched the lower Bollinger band.
Price must be trading above the longer-term 200 SMA line at the time the signal occurs.
A stoploss should be placed just below the low of the bar that touched the lower Bollinger band.
Exit the position when the price crosses back below and closes below the median line of the Bollinger band.
And now here are the rules for entering a short position using the strategy:
Price must cross and close below the median line of the Bollinger band after having recently touched the upper Bollinger band.
Price must be trading below the longer-term 200 SMA line at the time the signal occurs.
A stoploss should be placed just above the high of the bar that touched the upper Bollinger band.
Exit the position when the price crosses back above and closes above the median line of the Bollinger band.
Let’s now look at this Euro Fx strategy in action. Below you will find the daily price chart of the Euro Fx contract traded on the CME.
Note that the price was trading in a tight range as evidenced by the narrow width of the Bollinger band. Soon afterwards, the price crossed above the median line of the Bollinger band and touched the upper Bollinger band. Soon afterwards, on the very next bar, the price moved back below the median line of the Bollinger band and closed below it as well. As such, this would have served as our short entry signal.
At this point, we would want to confirm that the price is trading below the longer-term 200 period SMA line. As we can clearly see, the price at the time of the signal was trading well below the 200 SMA line as shown on the price chart. As such, we would have entered a sell entry at the open of the next bar. That would’ve gotten us into the short position. The price continued lower for a prolonged period creating a relatively strong bearish trend, as the price hugged the lower Bollinger band during the entire downward price move.
Eventually prices began to consolidate and start moving higher. You can see the exit point where the price closed above the median line of the Bollinger band, ultimately taking us out of the trade with a healthy profit.
The Euro Fx futures contract is the most liquid currency futures instrument at the CME. And it is among the most widely traded instruments in the futures world as a whole. A Euro Fx trader can bet on the price of this exchange rate in an efficient and transparent manner.
The cost for trading this contract at the CME is relatively low. The typical discount futures broker may charge between four and eight dollars per side for a total cost of eight to fifteen dollars round turn per contract. You can expect to pay twice this amount with full-service futures brokers. Additionally, the bid ask spreads are extremely tight and generally that spread is only one to two ticks at most during normal market conditions. The Euro Fx futures contract is an excellent product that traders should consider including within their watchlist.