Trading with Gold Forewards
As we mentioned in another article, a popular way to trade gold online is to use futures or options traded on an exchange such as the CME Globex (previously the New York Mercantile Exchange Comex Division), the Chicago Board of Trade or the Tokyo Commodity Exchange. You can also trade “spot” gold, which lets you take a long or short position in gold while simultaneously taking the opposite position in the U.S. dollar, much like trading forex pairs. This is not the only way to trade gold, however. Individuals who are interested in entering this potentially profitable market can also trade gold forwards—although there are limitations and risks.
First, let’s review what gold forwards are. Just like gold futures and gold options traded on an exchange, gold forwards are contracts to deliver, or take delivery of, a specific quantity of gold on a specific date at a specific price. Therefore, like gold futures and gold options traded on an exchange, gold forwards can be used to increase profits or to manage risk.
There are important differences between gold forwards and gold futures and gold options traded on an exchange, however.
First, gold futures and gold options traded on an exchange are standardized contracts. Gold forwards, on the other hand, are traded on the over-the-counter market (OTC), which simply means in some context other than on a formal exchange, such as a dealer network. As a result, the price and terms of gold forwards are negotiated directly between two parties to meet those parties’ individual needs. That makes these trading vehicles more flexible than gold futures and gold options traded on an exchange, but it also exposes them to counterparty risk, or the risk that the party on the other side of the trade will not deliver on his or her promise.
Second, gold forwards cannot be transferred, so they are less liquid than futures or options, which can be sold to third parties at any point before maturity.
As a result, the market for gold forwards (which are often considered structured products) is dominated by gold-market professionals and institutional investors.
Again, a much better way for a smaller trader to trade gold is via futures or options, which can be used to make money on swings in the price of gold or to help hedge, or minimize, risk.
As mentioned above, you can trade spot gold, which lets you take a long or short position in gold for little up-front cost. We’ll talk about trading spot gold more in “An Introduction to Trading Spot Gold.”