Posted By: Ilan Levy-Mayer Vice President, Cannon Trading Futures Blog
Since the 19th century, and as early as the 18th century in Japan, futures trading exchanges have been a way to establish a fixed price for goods to be exchanged at a later date. Establishing these contracts can provide either sensible protection for the goods you need, or a lucrative investment when trading contracts themselves. Futures contracts, however, are very risky and have become a complicated endeavor as they have evolved. This guide will help you to understand the futures trading market and expanding your investment portfolio by opening a futures account.
What are Futures Contracts and How do They Work?
A futures contract is simply an agreement to buy or sell a specific asset at a later date for a pre-established price. The key is that these agreements are standardized and will trade on an exchange. The two parties will agree that the buyer will buy the given quantity of securities or the commodity, while the seller agrees to provide and deliver it at a fixed date and price. The reason for this is to avoid wild price swings in either direction among more volatile assets. For example, a manufacturing company that may need oil for their production may want to set up a futures contract. They will always need oil to run their business, so they will want to ensure that they are protected by locking in a fixed price for the asset in case prices go up. This strategy is known as hedging and is used in industries to protect the price of goods that are necessary for running their business.
In addition to hedging, one can also participate in speculating by buying and trading futures contracts themselves. Speculators have no need for the underlying commodity being traded. Instead, a speculator will carefully watch market trends and price movements of particular assets to make their decision. Without the need for any one asset in particular, a spectator will buy and sell futures contracts themselves with the goal to make a profit. If the price of an asset goes up, a futures contract with a locked-in lower price becomes more valuable, allowing the owner to sell it for more in the futures market. Opposite from hedgers who seek to save money, speculators are in the market to wager on price movements and will never actually see the asset being traded.
How to Trade Futures
Once you have decided on which strategy is right for you, and your commodity, you will need to open a futures account with a broker that supports that market. A broker will help to mitigate the risk you will be taking in the futures market. They will work with you to set up your strategy based on your experience with investing, your income and net worth. A broker will also help to guide you with careful research and advice. They will act as your safety net and as your advisor in the futures trading market.
Choosing Your Commodity or Asset
If you are not hedging, you will not have a need for any one asset in particular. So where do you start? While physical commodities such as oil, fuel, agriculture, or metals represent a large portion of the futures market, there are also futures contracts for many intangible assets such as ETFs, bonds, or bitcoin. The goal is to choose an asset that you anticipate will go up in the future. Predicting this increase is no easy feat. It takes careful planning and a close eye on the market you are looking to invest in to notice these trends and when they occur. We suggest partnering with your futures broker for this. Working as a team, you will be able to notice market trends and the ebb and flow of price movement for your chosen asset.
Understanding What Goes Into Your Futures Contract
As mentioned earlier, standardization is key when drafting futures contracts. Both parties must agree upon the parameters set out in the contract before it can move forward. These parameters will typically include:
- The quantity of goods and unit of measurement being used,
- Whether the trade will be settled through a physical delivery or a cash settlement,
- The currency unit in which the contract is denominated and quoted
- The grade or quality of the good if it is applicable.
Be careful that all parameters of the contract are firmly agreed upon by all signing parties, especially if you are a casual trader. Your futures broker is here to assist you and make sure that you clearly set out these agreements early. By doing this, you avoid getting delivered low-quality goods as a hedger and avoid having to sign for thousands of gallons of oil as a speculator when the contract runs out.
Risks Involved with Trading Futures
Ultimately, futures contracts were designed to reduce the risk of producers, consumers, and investors. However, when speculation, a large risk is involved. It is often necessary for speculators to have to borrow a substantial amount of money to magnify small price movements. This is inherently risky as it is based on a prediction. If your prediction is wrong, you could wind up losing more money than you initially invested.
With an increasingly large risk involved, navigating futures contracts can be daunting. Cannon Trading will help you to get started by partnering you with a professional futures broker. Our professional team members will help to advise you on which platforms and which investments are right for you, whether as a hedging opportunity or as a means to profit as a speculator. We will help to advise you on all of your trading needs and questions when they arise with our extensive background and knowledge of futures trading. Don’t go it alone, start your futures trading journey with expert assistance from Cannon Trading.
Disclaimer – Trading Futures, Options on Futures, and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources.