Futures trading is not for beginners, even more advanced traders need experience. It is a type of trading that can be found in a variety of markets, and there are apps and platforms that give you a channel to trade in futures. For something that doesn’t seem so much related to stocks and commodities, what exactly are futures contracts, what are they for, and should you get into them? We will find out.
What is futures trading? – meltdown
What is futures trading? You can’t start investing your hard-earned money into something you don’t understand, so we’ll give you a quick breakdown.
Futures contracts are derivative financial contracts. What does derivative mean? In the case of trading, it is a contract that “derives” its value from a group of assets, an underlying asset or a standard. Two parties enter into a contract to agree to buy or sell an asset or a security at a specified date in the future (hence the term), at a price that is also set. Keep in mind that there is a minimum price fluctuation for each contract known as the ‘retail’.
These trades take place in the futures markets or exchanges. In order to participate in futures trading, you will need an approved brokerage account to do so.
You might think that it sounds very similar to options trading, and you would be right, but there is one key difference. At the end of the contract, there is no guarantee on the value of the options, but in futures trading, the buyer is obligated to buy the asset and the seller is obligated to provide it.
We mentioned that futures contracts are traded in the futures markets. How is it different from other markets and exchanges? It is only for futures contracts. A typical contract agreement consists of information such as the quantity that the buyer is obligated to purchase and the delivery date for the seller. Examples of commodity futures include oil, metals, coffee, grains, and even cryptocurrencies such as Bitcoin.
Let’s break down the categories that you are most likely to find in the futures or exchange market with more examples.
financial futures contracts E-Mini S&P 500, NASDAQ, Russell 2000, and Mini Dow Jones.
currency futures contracts Many global currencies such as Australian dollar, Canadian dollar, British pound, yen, US dollar
Energy futures contracts Natural gas, oil and ethanol
metal futures contracts Gold, platinum, silver, copper and palladium
Livestock futures contracts Livestock for consumption like cattle
food futures contracts Coffee, sugar and cheese
Grain futures contracts Corn, soy, wheat, oats
Futures contracts – how do they work?
What is futures trading broken down into just a few steps?
Let’s take fuel for example because prices are astronomical at the time of writing. Suppose an energy company like Chevron and Shell wants to set the price and avoid potential increases in the future. The company will become the buyer, looking for contracts from the seller, who will be the fuel distributor, which states the exact amount for a specific price to be delivered at a specific time in the future.
stock futures contracts
We talked about the different commodities available in futures trading, but that’s not all you can handle as there are stock options as well. Individual companies may also have stock futures such as some ETFs. You may even find futures bonds as well.
Most of us are involved in any type of investment because we are betting that it will increase value in the future and make a profit for us. However, others are short selling, which actually makes a profit as the shares go down.
We explained what futures contracts are, but let’s go into more detail about what is stipulated in each.
- How the trade will take place (physical delivery, cash, etc.)
- Goods Quantity
- Details about the commodity such as grade, quality, etc.
- measuring unit
What is the purpose of futures contracts?
The main and perhaps the main reason for trading futures contracts is to hedge against potential risks in price changes. It is one of the best ways for large companies to do this. So, risk management is a big part of it, but the other half is all about speculation.
One thing to understand is before the contract expires, futures trades are highly liquid and can change. Why is this important? It is a great property for those who do not plan to own the item. What an investor like this does is profit from the market trend without being responsible for following.
A person who buys and sells before the expiration date will not be obligated to fulfill the conditions described in the contract. It is complicated, which is why we do not recommend futures trading for beginners. However, if you want to get into futures contracts and are open to learning and spending time on it, TopstepTrader is a great option. You can also consider NinjaTrader or Forex.com, but you can try TopStepTrader free trial first and then decide.
Futures Trading – Pros and Cons
The best way to know if a type of trading or investment is right for you is to weigh the pros and cons.
- Diversify your investor profile by allocating assets across different types of investments
- Participate in the short sale
- Possible tax advantages
- Speculation due to high liquidity
- Risk Management
- The deposit is usually a small part of the full amount
- It takes investment and business knowledge to be successful
- Margin opens more risk with an opportunity to make more profits
We talked about all the good things that come with futures trading from risk management to short selling. If you meet the criteria to follow in futures trading, you can reap all the benefits if you understand them.
It is very likely that the brokerage firm will ask about your investing experience, your total net worth, and even your income to determine the margins and risks they will allow you to address. Commission and fees are set by the brokerage and will vary. It depends on the services they provide as well. There are some companies that offer a lot of support and advice.
The futures market is very attractive for those looking to amplify a small amount of investment, especially with short selling. We see people in day trading who borrow money just to play in the futures market. While it is true that you can earn a lot of profits, the opposite is also true and you can lose a lot.
The Commodity Futures Trading Commission (CFTC) warns individual investors about volatility and recommends against it for those without the capital or experience. Again, there are platforms to use that can give you a taste of futures trading without much risk like going it alone.
The point we are trying to make throughout this article is that futures trading is a very useful form of investment to hedge against future price increases and to make a lot of money with a small initial investment when selling short. It is also important to recognize the risks behind futures trading, which is that high profits can also equate to high losses.