Futures Trading

Is futures trading a safe investment technique?

The loud shouting and signaling of bids on the trading floor of a futures exchange, undoubtedly conveys to people that they are witnessing total chaos. In actuality, future contracts replaced chaos and brought a sense of order to the markets.

A futures contract is an obligation to receive or deliver a commodity or financial instrument sometime in the future, but at the price agreed upon today.

Buying a futures contract is known as a long position. Selling a futures contract is known as a short position. A long position profits if the price rises, whereas, the short position benefits if the price falls.

A trader must have the initial margin requirement before entering into a position. Generally speaking, the requirement is about 5% of the value of the futures contract. However, exchanges continuously monitor risks and market developments. The constant flow of information is the catalyst in setting the margin requirements.

Future contracts increase and decrease in value for various reasons. Information pertaining to supply and demand is constantly assessed, which can effect the contract price in a positive and negative manner. The process of price discovery is constant.

Seldom does a trader actually take possession of the commodities. The large percentage of contracts are closed out before the maturity date.

Every individual who intends to participate in futures trading, must absolutely understand mathematically how price changes effect their investment. Future contracts are highly leveraged and often times produce wild swings in each direction.

The profits or losses of a futures contract can be calculated by doing the following:

Sell Price - Buy Price x Contract Size x Number of Contracts

Anyone who is thinking about entering the futures market for the first time, should seriously consider paper trading first. This is an exercise that will allow you to sharpen your trading skills.

1.) Basis: The difference between spot prices (cash) and futures contract price.

2.) Beta: A measure of volatility determined by how much a stock moves in relation to an index or average.

3.) Derivatives: Financial contracts in which the value is determined by the underlying instrument, such as a commodity.

4.) Hedge: A position established for the purpose of protecting an existing position.

5.) Open Contract: Contracts that have been bought or sold and are still outstanding.

6.) Premium: Total price of the contract.

7.) Resistance: A price level, where the rising prices have stopped and began to decline or channel.

8.) Support: A price level, where the falling prices have stopped and began to rise or channel.

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