FxBrokerReviews.org – Trading through futures allows investors to buy and sell commodities and assets at a predetermined date in the future. All the future trading takes place in the future market and through a future contract. The future contract binds both the dealers to complete the trade on the given date and at the determined value. The value of the contract is based on the value of the underlying asset.
Futures trading is mostly used by traders for hedging and to save themselves from major price fluctuations. If a price is decided in the contract then, the price fluctuations won’t affect the value of the trade in any case.
This is just a brief on what is futures trading. Keep reading below to answer questions like what is futures market? How to trade in futures? and understand all the features, components and risks, and regulations of futures trading.
What is Futures trading- Examples and definition?
Future trading involves trading an asset or commodity at a future date but with a pre-determined price. In this type of trading, the buyer and seller must abide by the agreement and complete the trade on the given date and price, irrespective of the market conditions. The predetermined time in futures trading is known as the delivery date and the fixed price is called the futures price.
To start futures trading both the seller and the buyer have to come into an agreement known as the futures contract. Let us take a futures trading example to understand it better :
For example: if someone buys an August natural gas futures contract (CL), According to the trade the buyer will buy 1,000 cubic feet of gas at the agreed price upon the August expiration, irrespective of the market price at that time.
Similarly, the seller is agreeing to sell the same 1,000 cubic feet of gas at the agreed-upon price. So the buyer and the seller come into a contract to buy and sell at a predetermined date and time. At the time of the expiration of the contract, the seller will deliver the commodity to the buyer.
What does a futures contract consist of?
Apart from the decided time and price, the futures contract holds several other conditions and terms of the trade. Take a look at how a futures contract looks
1. Underlying asset
The underlying asset of a futures contract provides information on value and the asset for trade. Assets like: metals, currency pairs, interest rates, agricultural commodities, energy products, and more are some futures and options examples available to trade. Every futures contract comes with a code for identification. This code consists of information about the underlying asset and the month and year of the contract.
2. Expiration date
The expiration date is the date at which the final settlement is done and the contract is closed. On expiration day, cash accounts are managed and the settlement price is used as the basis for valuation. After the expiration date, the buyer can make arrangements to get the delivery of the physical asset (if any) involved in the trade.
The price of a futures contract refers to the current amount of money required by a trader to buy or sell the underlying asset ahead of the expiration day. The price of a futures contract is similar to trading a currency pairing on the forex, as both the values are determined by a specified amount of the underlying asset. The current price of the futures contract is based upon its projected value at expiration. As market participants change and unknown future events transpire, the pricing may become obsolete or fluctuate.
Leverage is like a loan you take from the broker, to afford the value of the trade. It can be risky as it can either significantly increase profits or incur great losses. Leverage plays an important role in futures trading. All Futures contracts can be traded in multiple quantities or lots. A “lot” is the smallest quantity by which futures are bought or sold. Therefore, a broker sets a margin requirement to govern the maximum number of lots traded at one time.
There are two types of margin requirements:
- Intraday margin requirement: the amount of capital required to trade a futures contract.
- The overnight margin: the amount of reserves required in a trading account to hold a position through the session close.
- These margin requirements and the amount of leverage allowed in the trade are mentioned in the futures contract.
What is futures market?
A futures market is a financial market where participants come together to buy and sell commodities and futures contracts, set on a specified future date. Like all other markets, the futures market is also an electronic market, without any physical location. These are regulated markets and are registered with the Commodity Futures Trading Commission (CFTC), the organization in charge of the regulation of futures markets. All futures trading is mostly regulated by the regulating body of the nation in which they are based.
Some common examples of futures markets are the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBoT), the Cboe Options Exchange (Cboe), and the Minneapolis Grain Exchange.
What is the benefit of futures trading?
Futures trading involves less cost and protects traders from price fluctuations. A good future trading example holds several benefits for potential investors who want to start trading in the futures market. Take a look at some of the advantages of futures trading :
Allows Market Participation
Futures contracts as mentioned above are useful for traders who do not want to take risks. Investors feel protected in a futures market as it is unaffected by price fluctuations once the value is determined. This brings more participation from investors in the financial market who would otherwise not have access.
High liquidity allows traders to open and exit a trade when they wish to. A majority of the futures markets offer high liquidity. You can find high liquidity while trading currencies, indexes, and commonly traded commodities.
The determination of the price of the futures contract is quite simple and easy to understand. It follows the cost-of-carry pricing model under which the futures price is the same as the current spot price plus the cost of carrying the underlying asset until the contract matures.
There are a variety of futures and options examples from which you can trade. Assets like commodities, indices, precious metals, crude oil, energy resources and more can be traded in the futures market. It allows traders to diversify their portfolios.
The margin requirements to trade commodities as futures remain unchanged. They may be temporary changes due to market volatility. The stability of the margin requirement helps a trader to know in advance the amount they need to put aside as a margin.
Futures do not decay with time which means that their value does not decline even if they are in the market for a long period. Traders do not have to worry about the possibility of a erode in the profitability of a futures position or losing a winning position.
How to trade in the futures market?
Now that you have an understanding of the futures market, let us look into how you can start trading in the futures market :
You can either trade futures on your own or take assistance from the tools and managers provided by your broker. Here are the steps and a few strategies to help you start your trade in the market :
1. Learn about the market
Before you start trading in the futures market it is important to understand how the market works. You should be aware of the potential risks and cautions of trading. Moreover, before entering into any contract you should know all the terms and conditions used to bind the contract.
2. Choose a market or the type of commodity
Once you know how the market works, you need to be clear on the type of commodity you want to buy or sell. Futures and options examples to trade include commodities, precious metals, livestock, agricultural products, and more.
3. Learn trading strategies
There are several investing strategies to choose from, once you are familiar with the working of the market. Forex broker review has listed some of the helpful strategies that can benefit you
- Long call – going long means buying the contract when there is an expectation of the price to rise.
- Short Call – going short refers to selling the contract based on the market expectation that the value of the asset is going to fall.
- Calendar Spreads: in this, a trader takes both a long and short position on the same asset but with two separate expirations. The profit is earned through the spread.
4. Open a position
Once you are prepared and found a suitable broker, it’s time to place a trade in the market. Take the help of the various chartings and tools and keep a close check on the price fluctuations. There is always an unknown risk with trading so you should always monitor your positions.
Who is futures trading for?
If you still are wondering what is the benefit of futures trading, then let us take a look at the type of investors involved in this kind of trading and how it benefits them. Two types of traders participate in the buying and selling of futures contracts:
- Hedgers: the investors who practice hedging trade in the futures market to save money. hedging serves as a medium for institutional investors or companies, to manage the future price risk of the commodity. Hedgers involve in trading to get the physical commodity associated with the trade. Farmers, bankers, and producers are examples of hedgers.
- Speculators: as the name suggests speculates on the price movements of the futures commodities. Most investors take part as speculators. They can buy or sell futures to express an opinion and gain profit from the direction of the market for a commodity.
How Futures Trading is Different from Other Financial Instruments?
Trading in the futures market is settled at a future and pre-decided date, whereas other financial instruments are traded live i.e all the transactions have an instant execution. Furthermore, futures contracts come with an expiration date, which is not the case with other financial instruments.
For example: In the case of stock trading, when you buy stocks of any company it represents your share in a company and can be held for as long as you want to hold a share in the company. However, in futures trading, you can not hold the contract longer than the predetermined period. Therefore, the timing factor in future trading plays a crucial role.
Is futures trading safe?
If you are wondering if futures trading is safe, then we are here to help you clear your conception. Futures trading is safe and the futures market is a secure place to make investments. The regulation of futures markets exists as “self-regulation” along with an authority that overlooks all the traders. In the United States, the CME Group works as a self-regulatory body and is looked upon by the Commodities Futures Trading Commission as well. These regulatory bodies make sure that trading operations are conducted per adopted fair-trade policies to maintain transparency and authenticity.
Here it is important to note that the regulation does not protect the futures market from potential market risks. The market is considered to be risky like all other types of investments. Investments like owning equities, bonds, or currencies always possess a certain threat because futures prices depend on the prices of the underlying assets, whether it is futures on stocks, bonds, or currencies.
Also read: Complete Guide to Precious Metals Trading
Futures trading provides traders with many unique financial opportunities. The futures market is a good place for investors to diversify their portfolios and speculate on prices. However, the volatility and financial leverage present in the modern futures marketplace are capable of producing severe drawdowns of capital in relatively short periods.
Above we have answered all questions related to futures trading like What are futures markets? what are the benefits of futures trading? And is futures trading safe or not? After, reading this guide you will be ready to start trading in the futures market.