Futures trading: a beginners guide
Futures contracts enable traders to bet on the price of an underlying item, such as commodities, currencies, or financial instruments. An agreement between a buyer and a seller to acquire or sell an item at a future price and date.
Understand Futures Contracts
CME and NYMEX trade standardized futures contracts. These contracts state the asset’s amount, quality, price, and payment date.
Futures contracts oblige both parties to complete the agreement at the designated date, unlike options contracts, which provide the holder the right but not the responsibility to purchase or sell the underlying asset. Futures contracts are legally binding.
Traders utilize futures for several reasons:
Hedging: Futures contracts may hedge asset price swings. A farmer may get into a futures contract to sell their harvest at a certain price to protect themselves against price drops.
Speculation: Without owning the asset, traders might speculate on its price. Traders may benefit from price swings by buying or selling futures contracts.
Leverage: Futures contracts let traders control a lot of an asset for a modest investment. Leverage boosts gains but also raises losses.
Futures contracts work
Suppose you’re a trader who thinks oil will rise in three months. You acquire a three-month oil futures contract for 100 barrels at $60 per barrel.
You may win $10 per barrel by selling the futures contract if oil reaches $70 per barrel by settlement. However, if oil drops to $50 per barrel, you lose $10 per barrel.
Futures contracts are marked-to-market daily, so profits and losses are paid at the market price. This assures that both contracting parties have enough margin balances to satisfy their commitments.
Futures dealers seldom aim to physically deliver the underlying product. They balance their holdings by making a countertrade before settlement.
Risks and Benefits of Futures Trading
Trading futures contracts is lucrative yet risky. Beginners in trading must recognize and handle risks. Major futures trading risks include:
Asset values may fluctuate greatly, causing large profits or losses.
Leverage Risk: Leverage increases profits and losses. Traders should limit leverage.
Market Risk: Economic variables, politics, and supply-demand dynamics impact futures contracts. These market concerns might affect contract performance.
Futures trading has hazards but also benefits:
Futures markets are very liquid, with enough buyers and sellers to trade at any moment.
Diversification: Futures contracts on several assets enable traders to diversify their portfolios.
Futures markets provide effective price discovery since information is promptly absorbed into market pricing.
Conclusion
Traders like futures contracts for their flexibility and profit possibilities. Beginners should be cautious and comprehend futures trading dangers. To navigate the futures market, one must educate themselves, create a trading strategy, and manage risk.
References and sources:
1. “Futures contract.” Investopedia. Investorpedia.com/terms/f/futurescontract.asp
2. “Understanding Futures Contracts.” CME Group. What is a futures contract? https://www.cmegroup.com/education/getting-started/