Futures

May 7th 2016

Overview

In financial terms, futures are forward contracts to buy or sell a standard quantity of a certain instruments, such as gold, silver, grains, oil, stock indexes, bonds, currency or bank bills of exchange, on a specific future date at an agreed price. Futures contracts are forward contracts, which mean they represent an assurance to make a certain transaction at a future date.

How It Works

Suppose an investor is into coffee futures and expects the value of coffee to rise. He enters into an agreement with a coffee supplier to obtain "x" amount of coffee products at the current market price, and makes a certain percentage of payment to seal the contract by locking in that day's price.

If the price of coffee rises as he predicted, instead of paying higher prices, he procures the products at the previously agreed price which was the current price when he entered into the contract. The profit margin is greater because he has paid less than the price that exists now. Conversely, if the price drops, he is still obligated by the contract. The supplier then demands a margin call, that is, an additional payment.

Benefits

Futures market has several benefits over other forms of investment which makes it the most popular day trading market. Day trading can be done without any restrictions for 24 hours a day, unlike the stock market. An investor has the assurance that he is investing in tangible goods that can be resold to recoup at least some part of the investment in the event of a wrong prediction. An educated investor faces less risk, especially in forecasting commodity values because they have a wide demand. Moreover, futures investment includes an array of instruments that have good range of price movement and liquidity. Futures markets can be traded in both directions: upwards or downwards. Since a trader can trade in both directions, he only focuses on the distance the market is moving regardless of the direction.

Cost/Pricing

An investor pays only a portion of the cost for the underlying item. This kind of leverage makes it possible to start futures trading with a small down-payment rather than paying the whole cost up-front. This makes it popular among those who want to participate in currency and commodity markets.

Timing

It is very important to have vigilant eyes in futures investment. When a negative downturn is seen in a particular future, it is wise to get out of it and put the money elsewhere to avoid further loss, rather than holding out. The value of the future might not rise again till the contract date. Past performance is not an indicator of the future performance. Time is, therefore very crucial.

Companies/Industries

Future trading is only for very sophisticated investors. Once you decide that you would like to trade commodity futures, you will have to find a commodity broker in order to trade. There are roughly 1,500 commodity brokerage firms in the US. There is a high concentration of commodity brokers in the Chicago area. New York, California, and Florida also have a good portion of the commodity brokers. Most stockbrokers are not licensed to deal in commodities, so it is likely you will have to find a broker that specializes in commodities.

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