What is Futures Trading?
futures trading definition: futures trading means an agreement to buy or sell an asset at a predetermined date and price. The underlying asset can be a commodity, stocks, ETFs, or other financial instruments. In the given trade, the agreed party buys a quantity of a commodity, and the other party agrees to sell the contract, which they agree upon a specific price.
Traders use the futures contract market, investors, and even companies to get hold of the supply chain and make it available for their production purpose. An asset like steel is an example of a commodity traded in futures contracts. Likewise, traders can trade in a futures contract like S&P 500 as an example of futures contracts.
Futures contracts get primarily applied on the stock exchanges that are standardized and have different parameters.
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Things Which Are There in Futures Trading Contract
Now you have understood the futures trading meaning, let’s discuss the required items.
- The trade-in futures trading is settled by cash.
- The number of goods.
- The currency unit and the currency in the futures contract
- Apart from this, the grade and quality of the raw material.
So, when you are planning to trade in futures, you must be aware of the obligation you need to pay and the mentioned notes in the contract, which can be the delivery of commodities and other extra charges. Futures trading revolves around the derivative product. The derivative value depends upon the underlying value of assets such as oil, gas, etc. Like any other securities in the financial market, the derivatives are volatile to gains and losses. Many times, when the contract expires, the trader who holds the futures contracts will have to pay in cash.
In simple terms, futures trading means the futures transaction between the two parties that agrees to transact security or commodity at a fixed price. Therefore, you can say most futures contracts are speculative. The futures trade is an opportunity to make a profit or hedge risk and not take the delivery of physical goods or security for most traders.
There are Many Types of Futures Contracts Which are Tradeable in the Stock Market
1. Interest Rates
7. Natural Resources
Remember that futures contracts require physical delivery. So in this situation, the investor holding onto the contract deal will need to manage and store the goods, handle physical storage, and maintain futures contract assets.
Benefits of Futures Trading
Investors can use futures trading for various benefits. Some of them are as follows:
In futures trading contracts, control a small portion of the money. But the result of the investment is enormous, and the risk of trading is comparatively higher than other financial instruments.
Futures contracts invest in different commodities such as gold, oil, energy, and other raw materials.
Futures market trade at a particular time of the day. Traders will know whether the stocks open up or down. Consider the example of stock index futures, a potential indicator of the stock market condition.
The futures contract takes place in huge numbers. With the vast demand and trade of futures contracts, there is flexibility to get in and out of futures trades. So there is high liquidity, but the liquidity is low for obscure contracts.
There are chances of risk and loss in futures contracts. However, if you realize a considerable loss and see minimal investment recovery, you can simply exit your existing position and take a minimal loss on your financial portfolio.
The commissions on a futures trade are low compared to other transactions. The total brokerage charge will be around 0.5% of the contract value. But this is solely dependent upon the broker you select for your futures trading. It helps to make future investments better and more reliable.
In futures trading, you can make a significant advantage that makes investors appeal to a high leverage position and increase the contract size to make the contract critical to market position. Traders must analyze and absorb market conditions to take advantage of futures contracts.
How to Trade in a Futures Contract?
It’s relatively simple to trade in futures contracts. You need to open an account with a broker that provides a futures and options account to trade on different derivative instruments for a start. There are specific criteria to become a part of F&O trading from each broker firm. The risk and experience must be above average to be a futures trader.
It is helping in just future prediction and managing your financial instruments. Some broker apps provide a dummy trading account and scenario to practice F&O trading. However, even if you know about stock trading, you will still struggle to participate in futures trading.
Consider the example of a futures contract for the price of crude oil when a trader enters a trade at Rs. 50/- per barrel. As the crude oil barrel comes in 1,000 barrels, the investor position is worth Rs. 50,000/-. So the trader needs to pay an upfront margin to the broker on these futures contracts.
Suppose the crude oil fluctuates from four or more months and rises to Rs.65/- per barrel. Then the trader decides to sell its contract, and the exit position will profit Rs. 15/- per barrel will be a total of Rs. 15,000/- profit in total.
And in the case of loss, if the barrel price goes down to Rs.40/-, the trader will get a loss of about Rs.10,000/-. So the profit and loss in the futures contract are pretty expected and risky. Some broker firms provide good research and advice along with information and a chart that can help you make better decisions.
Example of Futures
In futures trading, players sign contracts to buy or sell specific assets, such as commodities, currencies, or stock market indices, at a defined price and date in the future. These standardised contracts, also referred to as futures contracts, are exchanged on regulated exchanges. Through futures trading, investors can make predictions about the changes in value of the underlying asset without actually holding it.
Let’s take the case of an investor who believes that the price of crude oil will increase in the future. They can sign a futures contract to purchase a specific amount of oil at a specific price. The investor can make money by selling the contract at a higher price if the price of oil does rise.
Futures trading means investing in futures contracts to make substantial profits. But beware that borrowing money can be a risky affair and affect your professional life. The market condition plays a directly proportional relationship with futures contracts. Futures trading also helps you trade in shares of ETFs and even in bonds and government securities. Many traders and investors put their money to gain profit and leverage than just owning the securities directly from the stock market. I hope you found this article helpful in understanding the futures trading meaning.
Frequently Asked Questions (FAQs)
The futures represent an obligation to buy or sell a specific stock or commodity amount and quantity. The option does not oblige to buy or sell particular stocks or commodities.
The futures contract is riskier because of the obligation to buy or sell the asset in the mentioned contract. The margin fee imposed on the futures contract is much higher than the premium one has to pay to trade options. Apart from this, traders have to settle their M2M (mark to mark) losses daily if they make a loss. Due to these reasons, the capital one requires to trade futures also exceeds that of trade margins.
A call option is a contract that gives the right to buy an underlying asset at a specified price within a specific period that is locked in the contract.
A derivative is a contract whose value depends upon one or more underlying financial assets. The price of a derivative depends upon the fluctuations of financial assets in that particular derivative. The four common types of derivatives are futures, options, forwards, and swaps. Out which futures and options are the most commonly traded derivatives in the equity, commodity, and currency segments.
Trading derivatives like futures is a very risky play, so investors new to the stock market are generally advised to avoid trading them. Firstly, to trade futures, you need a very high capital. You also need to understand the concepts like margin fee and settlement of MTM losses concerning futures. And lastly, futures are speculative investments. There are indeed strategies to trade futures, but you have to holistically comprehend the futures market. So nonetheless, apart from being risky, there is also a high entry barrier to trade in the futures segment.
Futures trading can be profitable if executed with proper research, analysis, risk management, and a well-defined trading strategy. However, it is important to note that futures trading involves inherent risks, and profits are not guaranteed. Successful futures trading requires knowledge, experience, and the ability to navigate the complexities of the market.
The best time for futures trading depends on the specific market being traded and the trading strategy employed. Different futures markets have their own trading hours, and certain markets may be more active and liquid during specific times of the day.