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.
