Point of Futures Trading
A futures contract is an agreement to buy or sell an asset at a specified date in the future, at a price agreed upon now. Traders use them for a wide variety of assets, from agricultural commodities such as wheat and corn to energy products like crude oil and natural gas to precious metals including gold and silver. There are even financial futures contracts that trade interest rates and foreign currency.
Investors typically open a futures trading account because they want to speculate on the price of an asset without actually owning it. They do this by using leverage, which allows them to take a large position with only a small amount of money. However, this high level of leverage comes with greater risk, and investors should be aware that they can lose more money than they deposit in their account.
When a market is well-developed, the pricing of a futures trading contract is usually rational and reflects the balance of supply and demand for the asset at some point in the future. The price is also adjusted for the risk-free rate of return until expiration and the cost to store the commodity until delivery.
What is the Point of Futures Trading?
In less developed markets, the pricing of a futures contract can be more volatile. For example, in the case of a futures contract for a physical commodity such as grains or oil, the market may not be large enough to meet demand and the price may rise faster than it falls. These kinds of price movements can make speculating on the futures market more risky for traders.
Traders can go long or short on a futures contract, and many of them choose to trade based on the price movement of the underlying asset. For example, if an investor thinks that stocks will fall, they would short-sell a stock index futures contract to reduce their exposure to the market and make money if stocks do indeed fall.
Another reason to trade futures is that the contracts are standardized and can be traded on a formal exchange. Unlike a private transaction, a futures contract is enforceable by law and can be enforced against a party that breaks the terms of the contract. Traders can also hedge their positions in the futures market by buying or selling physical goods that are related to the asset being traded.
When you open a futures trading account, brokers will ask you for more details about your investing experience, income and net worth than they might in a standard stock brokerage account. This information helps them determine how much leverage to offer you, and it can vary widely among brokers. Some offer very high levels of leverage, while others don’t offer any at all. As a result, you should shop around to find the broker that offers the best combination of price and services for your needs. In addition, you should remember that fees can vary based on the volume of transactions you make.