Futures Trading FAQ
What is futures
trading?
Futures trading is the buying and selling of futures
contracts. These are contracts that involve the purchase or
sale of an underlying instrument at a set price on a certain
date. For example one might enter into a contract that requires
the purchase of 100 oz of gold for $600/oz in January 2007.
There are futures contracts in
currencies, equities, commodities and other financial
instruments.
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Futures
Trading Info
Futures trading is the art
and business of buying and
selling contracts on
commodities. These contracts
are specific in detail i.e.
5000 bushels of corn would make
up a corn contract traded on
The Chicago Board of Trade.
Each commodity contract also
spells out the grade of the
commodity and in the case of a
grain contract whether it is
new or old crop.
The attraction of futures
trading is a small amount of
margin money that can control a
contract that represents a
value fifty times the margin
needed to control one contract.
An example would be putting up
$500 to control one corn
contract, which is 5000 bushels
of corn. A penny change in the
corn price equals $50. The
price swings due to weather or
crop problems can be 50 cents
to several dollars. As you can
see, this could mean huge
profits or disaster for the
futures trader or
speculator.
The opposite side of a
speculator is the hedger
trader. Companies like oil
companies or grain users trade
futures to lock in their cost
of needed product. A company
that makes products out of
copper could use the copper
futures market to lock up
copper prices for a year in
advance. If the price then goes
up like it has done in the
past, the company has protected
itself from the price
swing.
Futures trading is conducted
on exchanges located primarily
in Chicago, New York and
London. The Internet has made
current price information
available instantaneously.
Software manufacturers have
developed trading programs that
help to predict price
direction.
Speculative futures trading
is like trying to catch
lightening in a bottle. If the
trader succeeds, the amount of
money made can be counted in
the millions. If the trade goes
south, the losses can be just
as great. Suffice it to say,
futures trading is not for the
weak of heart.
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What are the advantages of futures trading? There are a number
of advantages to futures trading compared with trading the
underlying instrument directly. The main is leverage, i.e. the
amount of exposure to the underlying instrument that you can
get for a given outlay of money. Using the example above, the
initial outlay will usually be only a fraction of the value of
the contract, called “margin”. Thus the investor gains exposure
to 100 oz of gold for just a few hundred dollars. Another
advantage of futures trading is, given the liquidity of the
futures market, transactions costs are usually very
competitive. A further advantage is that investors can usually
go “short”, i.e. they can be the seller in the futures
contract. This is an advantage if they believe the price of the
underlying instrument is set to fall. Finally there may be tax
advantages compared with normal investing depending on the
local taxation regime.
What are the disadvantages of futures trading? Leverage works
both ways. If an investor purchases a futures contract, paying
only the margin, and the price of the underlying asset falls,
then investors can lose more than their original stake.
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