Teeka Tiwari

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I recently wrote about how to get into currency trading with your eyes open. Now I want to talk about some of the advantages of trading currencies on an exchange rather than through a forex broker. I also want to talk about some strategies I use when trading currencies.

The Exchange Advantage

The key benefits to trading on an exchange are transparency and security of your funds. The exchanges take no principal position against their order flow. Every trade is reflected right there for everyone to see.

Every trade that takes place on an exchange such as the Chicago Mercantile Exchange (CME) is guaranteed by the exchange. Even if the counterparty on the other side of the trade were a Lehman Brothers and goes bust, the exchange will make good on your positions.

Up until a few years ago, I would have given this less credence as a real advantage. But we have seen some massive financial names flame out: Refco, Bear Stearns and Lehman Brothers were all organizations considered too big to fail.

For the most dynamic, highly leveraged day trading, though, going through forex brokers still has an edge over the exchanges, with the key decider really being the amount of leverage one can employ. Forex offers 100-to-1 leverage and, in some instances, as high as 200-to-1.

CME currency contracts typically offer leverage ratios in the 20-to-1 range, and you have to pay commissions. Forex trades are commission-free. However, forex can end up costing you more, as brokers get compensated via the bid/ask spread.

The exchanges, specifically the CME, are more individual-investor-friendly, in my opinion.

A Low Risk Way to Trade Currencies

Just recently, the CME launched a series of new currency pair contracts called E-Micros. They are a truly revolutionary financial product.

Each E-Micro contract is one-tenth the size of a standard currency pair. (Currencies are traded in pairs -- that is, going long one and selling another against it.)

A big fear for novice investors just starting out with futures is that they might get saddled with a couple of hundred thousands gallons of heating oil or have to come up with millions to cover bad currency trades.

The E-Micro currency contracts are typically for $10,000 to $12,500 worth of the underlying currency. This is a far cry from normal-sized $100,000 to $125,000 contracts.

The other advantage is that the margin requirements on the Micros are very low, ranging between $300 and $600 per contract.

For someone looking for a very low-risk way to enter the world of currencies, the CME's new E-Micro contracts are an excellent tool. If you are totally wrong, you are not going to get killed on a one-lot position of an E-Micro currency contract. These contracts take a lot of the fear factor out of currency trading.

Whenever you are trading something new, you want to trade the smallest size possible until you get comfortable. E-Micros are the perfect product for the budding currency trader. The CME even offers free real-time quotes on their currency pairs.

If you are thinking about currency trading, I would strongly recommend using the E-Micro product as means to get your feet wet first before attempting to employ more-advanced, highly leveraged strategies on forex.

Leverage by itself isn't either good or bad, the same way a gun isn't either good or bad. It's all in the application of the tool.