Future Trading! I know you may be a bit surprise to hear the word future. I was no different, when I heard the word for the first time, I too was surprise. Future Trading isn’t as famous as forex, stock or commodity but it is starting to get the attention of most small scale investors and retail trader.
In this article we will look at what are futures and some other basic things you need to know about Future Trading.
What is a future?
A future is a contract to deliver or accept delivery of a specific quantity of a commodity at a certain time.
Let me explain a bit;
In Future Trading, the buyer and the seller will decide when to sell and buy a goods or whatever at a certain time in the future, hence the name “Future Trading”.
A future’s contract is binding on both the seller and buyer, unlike in options where the buyer/seller has the right but not the obligation to take delivery –I will explain more on options on a later day.
Buying a stock makes you a part owner of a company. But when you buy a future you don’t own anything, but enter into a binding contract for a future purchase of a merchandise it can be a cargo load of wheat or Treasury Bonds, currencies, commodity such as Gold or Silver etc.
Years ago, one of the popular financial assets to trade were stocks. In stocks, an individual could hold onto a losing company shares for years without selling it off but not in futures.
The introduction of internet connection made life a bit easier as anybody from anywhere can partake in this Financial Market thus making Currency Trading to be widely traded.
In Futures, there is a Central Exchange where there is regulation; in terms of centralize pricing and clearing, that explain why very few broker trade them.
The price of any market (commodity, stocks, bonds, precious metals, grains, oil, etc.) will be relatively the same across all other exchange because of the regulation of centralize pricing and clearing.
As I have earlier said, that in stock and forex you can hold unto a losing trade as far as your margin can carry it or as far as your capital. In Future, we have the existence of delivery date (expiration date) which forces the seller or buyer to act accordingly rather than to be day dreaming; waiting for a miracle to happen in the market.
How Does A Future Work?
To understand how future works, let’s give an example. Let’s say its February and gold is trading at $1,000 per ounce your analysis indicate that it is likely to rise to $1,100 within weeks with expiration date of 3 months. With a margin of $100,000 you can
buy a 100 ounce gold bar from a dealer, if your analysis is correct in a few weeks your gold will be worth $110,000 you can sell it and make a $1,000 profit, Nice. Let’s recap what just happened in a future market since its February, April is the next delivery month for gold.
One future control 100 ounce of gold if your analysis is good you make your profit else you lose part or everything and if the expiration date reach, you are forced to close your order at whatever price the market offers at that time and if it happens to be higher than the price you bought you make profit but a minimum profit compare to the initial and if it happens to be below, well that’s a loss.
Types of Future Traders
There are two types of futures traders we have:
Hedgers are not necessary interested in making profits because these guys are the big guns in the market. They use the future market to offset and reduce their risk in the market.
Let me give an example:
Let say a company called ABC are into the production of orange juice, these guys need a large quantity of orange periodically to be able to produce the orange juice daily. If they are to source there orange from the United State of America and want to buy 1 million pint at a rate
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of $100 per pint. Because of fear that the price of orange might skyrocket to $150 per pint or more, they can hedge their risk by buying the amount of orange they need in the future market. So we can see they aren’t necessary in for the profit but to off-set their risk –but if the price should fall below $100 to let’s say $70 per pint, it means they will still continue with the contact of $100 per pint, paying a little more expensive.
These guys are in for the profit and nothing more they aren’t interested in physically owning the assets or even delivering it.
They speculate only for the gains, they buy when they think or feel that the price for a certain asset is going to be expensive in the future or sell if they think or feel that it is losing its value.
We both fall under these category and unfortunately we most time do not buy from the exchange but rather from the brokerage firm, trading the CDF (Contract for Difference) I will speak more about that CDF my later article.
Is future dangerous for trader?
Most people are flooded with greed that they fail to understand that the markets do not move in a straight line. Charts in the market is filled with false break out, false reversal and trading range, there is a probability that Gold might rise from $1,000 to $1,500 in a few days and might dip down to $890 and range in that zones for months.
In summary, trading future might look dangerous at first but the danger is not in future but in people who trade them. A trader with a good money management skills, trading future can be very promising with a high rates of return but remember it demands an “ice cold discipline” once you mature as a trade, take a look at futures they may be right for you I recommend you read “winning in the future market by George Angell, a very good book for aspiring future traders”.
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