Futures are financial derivative contracts that require the parties to transact assets at a future date and price. The seller or buyer must either purchase the asset or sell it at the agreed price regardless of current market prices at the expiration date.
Many financial players can use the futures market, including investors, speculators, as well as companies who want to actually take physical delivery or supply the commodity. It also includes a wide variety of assets. Futures contracts can also be used to trade oil, which is an example of a commodity that can easily be traded.
Futures trading is risky and requires active participation. Characteristics like seriousness, preparation, and commitment are necessary to trade well in future. This means you need to learn new techniques and develop new routines. It is essential to be able to constantly review and modify your strategies and plans in order to improve your trading skills.
Futures are contracts that allow you to buy or sell specific commodities at a certain price and at a particular date in the future. You must be connected to the world via television, the Internet, and other news sources to be a successful futures trader.
This venture requires significant financial resources. To be able to succeed, you will need a computer and a trading program.
Characteristics for Futures Contract
Futures contracts are all-time-based. They expire at some point in the future. The expiration of a futures contract is a trading decision.
- You can sell the contract and then roll it over (that’s, you buy another contract for the asset with a later maturity).
- You can sell the contract and keep your profits or losses.
- You will be given the commodity, equity or product described in the contract.
Daily price limits
Futures contracts have limits that can freeze prices, but not trade, due to their volatility and potential for catastrophic losses. Limits are intended to allow markets to cool down during extremely active trading. The market can trade at a limited price, but not above it. Variable limits are available for some contracts. This means that the limits can change if there is a market closing at the limit.
Before trading can begin, most brokerage firms require that individuals deposit a minimum amount in a brokerage account. The industry’s average figure is $5,000.
A $5,000 deposit with a brokerage firm is unlikely to be enough to give you a great trading experience. Expert traders suggest that $100,000 is the best amount to have, while $20,000 is the most realistic amount you can work with. These aren’t hard-and-fast rules.
Speculators and Hedgers
Hedgers and speculators are the two main types of traders. Both groups are trying to achieve different goals when they enter the futures markets.
Hedgers not only trade in futures but also in the commodity or equity that the contract represents. Futures contracts are traded to protect the future price for the commodity which delivery will be taken and then later sell in the cash market. They can protect themselves from future price risks by buying and selling futures contracts.
Speculators place their bets on price changes for one reason: profit. They don’t care if the prices go up or down, they simply want to ride the price trends of products for as long as they can while still trying to cash in before delivery.
Futures markets are efficient because of the interaction between hedgers and speculators. As the underlying contract nears expiration, more information about the market at the delivery time becomes available, and the efficiency and accuracy of the demand and supply equation increase.
Futures contracts can be attractive for both long-term buyers (people who want to purchase commodities at the lowest price possible and sell them at the highest price possible) and short-term sellers (people who hope that prices will fall).
They provide price and timing certainty and lower volatility (the speed at which prices fluctuate up and down). Hedging is a way to lock in a reasonable price margin, which is the difference between the future price of the commodity and the cash price of the commodity. It also helps reduce the risk between raw material costs and retail prices of the final product.
Advantages of Future Contracts
Futures markets have high liquidity, particularly for currencies, indexes, and commodities that are commonly traded. This allows traders to trade when they want.
Future trade commissions are extremely low and are only charged once the position has been closed. The commission or brokerage total is typically 0.5% of the contract’s value. It depends on the broker’s level of service. A full-service broker may charge $50 per trade, while an online trading commission can be as low as $5.
Futures pricing is much simpler than the Black-Scholes Model-based options prices. It is usually based upon the cost-of-carry model. This means that the futures price can be determined by adding the cost to carry to the asset’s spot price.
A futures trader with good judgment can make quick money because they have 10 times the exposure to normal stocks. Future market prices tend to move quicker than those in cash or spot markets.
Drawbacks of Futures Trading
Futures contracts have definite expiration dates. Even if the contract has fixed prices, the prices may become less attractive as the expiration date nears. This can lead to futures contracts becoming worthless investments.
Like banks offering too many loans at fixed rates and increasing the chance that their loans will have lower market rates, it is not unusual for them to offer loans with low market rates. As futures contracts expire, they are subject to similar risks.
There is a limit to how much a commodity’s price can fluctuate each day. A commodity’s value will change rapidly and traders won’t be able to trade. If a futures trader is caught in a trade that makes limit moves daily, he or she may find themselves stuck with no options but to end the loss.
The Danger of Leverage
Futures contracts offer both an advantage as well as a disadvantage. The advantage: Futures contracts can be purchased for as little as 5 percent and 10 percent of the contract’s actual value. The downside is the often rapid movement of futures prices.
The contract prices can fluctuate daily, sometimes in minutes. If Lady Luck isn’t smiling at you, your broker will call you to inform you that your margin account has fallen below minimum levels. You must immediately transfer more cash into your account.
Futures contracts have a zero-sum advantage. The other party can gain millions of dollars if one party loses millions. These contracts offer investors an alternative investment option to maximize profits and hedge risk. Despite the higher volatility of the market, investors can benefit from low trading costs and greater profit potential.