The futures market is a fundamental part of modern finance, where standardized contracts known as futures contracts are traded. We at Moneyplantfx have a solid understanding of this active market and we believe it is good knowledge for all people to understand how this market works whether you are looking to expand your trading options or looking to manage your financial risk.
A futures contract is your commitment to purchase or sell an underlying asset at some point in the future and at a price set today. The underlying asset may be a stock, commodity, index, currency, or something else entirely. The contracts specify the quantity, price, and date of delivery so all parties understand the specifics of the trade. Futures provide opportunities for individuals and institutions alike to hedge risk, speculate on price movements or arbitrage prices if they are misaligned in the market.
At Moneyplantfx, we educate our clients about the participants of futures trading, along with their roles and motivations.
1. Hedgers –
These market participants could be companies or individuals holding an asset, wanting to avoid being exposed to price risk. For instance, hedgers can avoid surprise costs in the future by locking in a price today.
Long Hedge (Buying futures to ensure you pay a specific amount for an asset – protects against price increases.)
Short Hedge (Selling futures to ensure you receive a specific amount for an asset – protects against price decreases.)
2. Speculators –
Speculators provide value by taking on risks and trading futures contracts for gains on price changes assuming they do not own the underlying. A speculator can take a long or short position if they believe prices will rise or fall, respectively.
Long Position: Purchase a futures contract as speculative activity if they believe prices will rise.
Short Position: Sell a futures contract where they also speculate if they believe prices will fall.
3. Arbitrageurs and Intermediaries –
Arbitrageurs – can earn profits by buying and selling the same asset across various market(s) when they identify price discrepancies.
Intermediaries – which include brokers and exchanges, take on risk by facilitating trades, maintain settlement, and develop liquidity.
Day traders and margin traders are other market participants that are also active that have reduced time horizons that regularly buy and sell positions between and intraday. Margin traders are also known to use leverage whereas day traders typically do not.
Before we get into the different types of futures contracts, it is important to understand the difference between cash markets and futures markets:
Cash Market: Cash markets are where you buy and sell the asset now. The transaction is immediately settled and the asset is exchanged and delivered right then and there.
Futures Market: Futures markets are where your transaction will be settled and delivered at a future point in time. and price and terms will be agreed upon today.
At Moneyplantfx, we make it easy to understand market differences and determine your best trading path.
Futures contracts come in various forms. Being mindful of these different types of futures contracts can help traders get properly aligned and with the right instruments based on their market view and motivation for trading. Below is the most common types:
1. Commodity Futures
Commodity futures relate to physical goods, which include the following:
Typically, producers and consumers hedge against price fluctuations in commodities. In addition, investors may speculate on price movement.
2. Financial Futures
Financial futures are contracts on financial assets such as:
These futures contracts are useful as risk management tools or as substitutes for the aforementioned assets to hedge against interest rate risk or fluctuations in Forex rates.
3. Index Futures
Index Futures are based on stock market indexes. For example:
Index futures allow an investor to value a market wide or index driving force and not an individual stock.
4. Currency Futures
Currency futures are described as buying and selling standardized contracts of currency pairs.
They provide a hedge against Forex risk and/or speculation on trends in the global economy.
5. Interest Rate Futures
Interest Rate Futures are contracts based on debt instruments, i.e. treasury bills or bonds.
They are used to hedge against movement in interest rates, which could impact a consumer or corporate cost of borrowing or returns on savings.
Here at Moneyplantfx, we believe in the importance of risk management, which starts with an understanding of margin and leverage.
Margin –
Margin is the initial deposit required to open a futures position. It is a fraction of the total contract price, which serves as collateral for your potential losses.
Leverage –
Leverage allows a trader to control a large contract with a small amount of money by magnifying the potential profit but increasing the risk of loss.
Here are some reasons the futures market is a common choice for many traders:
Liquidity: High volumes of trading create ease when entering and exiting
Transparency: Prices are public and standardized
Hedging Tool: Useful for businesses and investors to transfer risks of the future.
Diversification: Easily gain exposure to several asset classes.
Opportunities in Speculation: Traders can profit in up and down markets.
The futures market offers a strong combination of speculation, hedging, and opportunity. Traders must understand the dynamics of how the market works and the role that various market participants play to make choices that fit their risk profile and bias in the marketplace.
Moneyplantfx is dedicated to providing education and helping people be successful. If you want to become involved in the futures market, consider opening a trading account with us so you can take advantage of our expert tools, training, and customized strategies.