TRADING IN FUTURES In financial investment terms a future contract is a formal and standardized agreement between two parties to buy or sell specific assets of a pre determined quantity and quality at a price reached by both parties involved with payment and delivery on the date specified. Trading of futures is presided over by the futures exchange, who mediate on behalf of the parties involved in the trade. The buying party of the asset in a future contract is said to be long and the selling party of the asset in a future contract is said to be short. These connotations reflect the expectations of the parties involved. While the buyer, purchases assets with an expected increase in price, while the seller goes into the contract with an expectation that the asset price falls in the near future. Future trading has two main categories which are the hedgers and the speculators. Hedgers use futures to reduce the risk of negative price movements in the underlying cash commodity. Cash prices and futures have historically moved in tandem hence the purpose of hedging. Futures traders who hedge are usually businesses or individuals who deal in the underlying cash commodity. On the other hand speculators which make up the second major group of future traders are made up of floor traders and other investors. The floor trader trades using the floor brokers or brokerage firms in order to make a trade. Speculators have important advantages when it comes to trading futures than other investments. If the speculators are good at reading the market, they can make much more money trading futures than other investments such as the real estate or the stock market, because the future market has a higher volatility than many other investments. While the volatility
of the futures market can be an advantage, it can also lead to huge losses if a bad trading call is made. Investing and trading in the futures market can be done with less than the actual amount of the asset being bought or sold. This is made possible by high leverages that enable the trader put up as low as 10%-15% of the underlying contract as margin. Compared to the real estate or stock market were up to 50% of the total value must be invested. Due to the high volatility of the future market and many factors that influence its movement, insider trading is very hard to achieve. On the trading floor, traders receive information (open out cry system) at once, making it a public, fair and efficient market. Trading in futures attracts small commissions when compared to other investment types. The commissions are to be paid only after the positions entered have been liquidated. Trading of commodities such as gold, silver and oil are very broad and liquid. Transactions can be open and closed as positions are executed immediately. While the risks are there in the futures market the advantages are there and for traders that are knowledgeable about trends and financial data announcements, the futures market could be highly lucrative with high returns over a short period.
Published on Feb 8, 2014