The forward market is an over-the-counter method of trading specialized futures contracts. While the forward market has a lot in common with the futures exchange, the goal and feel of the market is much different. In most cases, forward contracts are individualized to the parties involved and never sold off to other holders. The traders generally sit down and work out the individual details of the contract rather than using basic agreements. Since the process is often face-to-face and customized to the parties, it is common for the buyer and seller to know one another.
In the investment world, a future is an agreement to do something in the future. In many cases, these contracts amount to buying or selling an asset by a certain date for a specific amount. Once the future is drawn up, it may be bought and sold just like any other asset. As long as the future doesn’t expire, the actual holder is rarely important.
The investor’s goal in a futures contract is to anticipate changes in the market in order to buy or sell an asset with a beneficial exchange. For example, a stock is selling for $50 US Dollars (USD) at the time the future is sold. The contract states that within six months, the holder has the option to purchase that stock at the $50 USD price. The purchaser is hoping that price of the stock will increase and the seller is selling the option to raise immediate money against the potential loss of future money. If the stock price goes up to $75 USD, then the future holder may exercise his or her option and buy the stock cheap for an immediate $25 USD profit.
A forward market contract is nearly identical to a future from an investment standpoint. The only defined difference is in the method sold. A future is sold over an exchange, a dedicated platform for the buying and selling of assets. Forwards are sold over-the-counter, meaning they are sold by the issuer directly to another person. While this seems like a minor difference, it is important in this case.
On the futures exchange, the contracts are usually standardized forms with information pertaining to the sale filled in. On the forward market, the buyer and seller typically work together to create a unique contract that will be beneficial to both parties. Since the agreement is often more complex and double-sided than a future, a forward market contract rarely results in default or expiration. Lastly, the contract often stipulates that the forward may not be sold to another party.
