In this post, we’ll cover the essential tenets of the futures markets by examining two fundamental questions: “What are futures?” and “Why trade futures?” If you’re just starting to learn about futures trading basics, don’t worry ― the answers to these questions will help get you up to speed.
What Are Futures?
A futures contract is an agreement to buy or sell a certain quantity of an asset, on a forthcoming date, at a specified price. Often referred to simply as futures, the contracts themselves are legally binding financial instruments that represent an obligation to both the buyer and seller.
Here are three key characteristics of a futures contract:
- Derivatives product: Futures are considered to be financial derivatives products. This means that their value depends upon that of an underlying asset or group of assets. Popular contracts are based upon the commodity, currency, equity, and debt asset classes.
- Standardized: A futures contract is a standardized instrument. Being standardized ensures that each contract meets a predefined set of specifications, making it able to be readily traded on an exchange. Size, symbol, and pricing are a few examples of standard specifications.
- Perishable: Due to the fact that they are subject to expiry, futures are perishable in nature. Each has an assigned expiration date; upon it passing, the contract becomes null-and-void, virtually worthless.
In short, a futures contract is a derivative product that may be traded on an exchange until it expires. Understanding these three futures trading basics is imperative for anyone interested in becoming an active participant in the marketplace.
Why Trade Futures?
Featuring a vast array of products and markets, futures offer individuals from all walks of life a unique collection of opportunities. However, no matter your goals and objectives, there are two classifications of futures trading activities:
- Hedging: Hedging is the limiting of risk through the use of various investment vehicles. Futures are popular hedge mechanisms due to their wide scope of offerings and inherent flexibility. Commodity producers and fund managers are two examples of parties regularly involved in hedging with futures.
- Speculation: Attempting to profit from regular or sudden fluctuations in asset pricing is referred to as speculation. Buying and selling futures on short time frames is typically considered speculation because the goal is to make money directly from the act.
The beauty of futures is that they’re exceedingly receptive to both hedging and speculative enterprise. This is due in large part to the benefits of these futures trading basics:
- Liquidity: Futures are based on a collection of the world’s most popular assets, such as crude oil and gold. A high degree of public interest dictates that many products regularly exhibit robust participation and strong market depth. This is important because having an abundance of active buyers and sellers promotes efficiency in the process of price discovery.
- Volatility: Frequent and extensive fluctuations in futures pricing provides consistent trading opportunities. While volatility levels fluctuate from contract to contract, there is almost always a product on the move.
- Flexibility: The futures markets offer participants unparalleled flexibility. A participant can benefit from being either long or short a market, while enjoying the enhanced purchasing power available courtesy of margin trading.
In addition to being liquid, volatile, and flexible, futures are attractive due to their affordability. When compared to other financial assets, the cost of trade is minimal and availability of margin is extensive. Ultimately, trading may commence with a moderate amount of risk capital, at a reduced cost structure. When coupled with the other futures trading basics, legions of traders and investors frequently choose futures over other financial products.
Know the Futures Trading Basics Before Jumping into the Markets
For almost any endeavor, it pays to be “in the know” before jumping in with both feet. To learn more about all things futures, a free consultation with a broker at StoneX is a great way to get started.