Futures trading

Futures trading

The financial markets industry is vibrant and constantly changing, providing traders and investors with various options. Futures trading is an exciting and profitable option among the available options. Futures trading has become very popular due to its potential for large rewards, and capacity to protect against market dangers. Here, we explore the complex world of futures trading, including its tactics and effects on the global financial system. 

What is futures trading? 

Buying or selling of financial contracts that require the parties to buy or sell a certain asset at a predetermined price and date in the future is regarded as futures trading. These contracts are also referred to as futures contracts. Examples of these assets include commodities, currencies, stock indexes, and interest rates.  

Trading in futures enables market participants to manage their risk exposure while making predictions about prospective price movements for the underlying asset in the future. Investors can gain from rising and falling markets since they can take long or short bets in futures contracts. Futures trading often occurs on regulated exchanges. 

Understanding futures trading 

Futures trading is the purchasing and selling of futures contracts – standardised agreements that bind the parties to purchase or sell an underlying asset at a certain price and later date. Futures trading enables market participants to predict how various assets, including commodities, currencies, stock indices, and interest rates, will change in price.  

 Futures trading aims to profit by predicting the direction of the underlying asset’s price movement. To profit from rising and falling markets, traders can take long (buying) or short (selling) positions in futures contracts. In the financial markets, it offers chances for hedging, speculating, and risk control. 

Working of futures trading 

The process of futures trading starts with a trader opening a futures account with a broker. The trader then selects an asset they wish to trade in, such as commodities, currencies, or stocks. They specify the contract size, the price, and the expiration date. The broker then matches the trader with another party who has an opposing view.  

Once the contract is made, the trader needs to monitor the market conditions and take action when necessary. If the asset’s price moves in the trader’s favour, he can sell the contract for a profit. However, if the price moves against him, he may suffer losses. The trader may close his position before expiration or let it expire.  

Traders make forecasts regarding underlying asset price changes by examining market trends, economic data, and other relevant factors. Profit and loss are achieved by comparing the contract price to the actual market price at the contract expiration time. 

Importance of futures trading 

• The expectations and views of market participants are considered in futures trading to determine the underlying asset’s fair market value. Pricing that is effective and transparent is a result of this price discovery process. 
• Farmers, producers, and investors who wish to control their exposure to price changes can do so through futures contracts. By engaging in futures contracts, they can lock in pricing and safeguard themselves against negative changes in the underlying asset’s value. 

• Investors may diversify their portfolios using futures trading by including non-traditional assets besides equities and bonds. Investors can improve their risk-adjusted returns and lower overall portfolio volatility by including futures contracts in their investment mix. 
• Futures trading offers capital generation and investment possibilities across various industries and asset classes, enabling investors and businesses to deploy money effectively. It encourages productivity and economic progress. 
• Speculators can take positions in futures markets based on their predictions of price fluctuations in the future. These investors increase market liquidity, promoting efficient trading and guaranteeing that there are always ready buyers and sellers. 

Examples of futures trading 

Trading in commodities futures contracts is an example of futures trading. Let’s consider the example of a corn farmer who wishes to safeguard himself against a potential drop in maize prices. The farmer might enter into a futures contract to sell a certain amount of corn. Corn costs US$4 per bushel, and the farmer anticipates harvesting 1,000 bushels in three months.  

The farmer sells a corn futures contract at US$4 per bushel to protect against price swings and guarantees a set selling price for the crop. The farmer can still sell the corn at US$ 4 per bushel, thereby balancing the loss, even if the price drops to US$ 3 per bushel at the contract’s expiration.  

However, if the price climbs to US$5 per bushel, the farmer may sacrifice prospective earnings while still being insured against possible losses. The following example shows how futures trading enables market players to control their risk exposure and safeguard against unfavourable changes in the price of the underlying commodity. 

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