Futures Trading: What is it and How to Trade Futures?


Futures involve the sale and purchase of certain commodities, assets, or security at a pre-determined price at some point in the future. To facilitate trade on the futures, exchange the futures contracts are standardized to check for the quantity and the quality. Anyone who is purchasing the futures contracts will take an obligation to both purchases or sell the underlying asset once the contract expires. Future contracts allow the investor to speculate the direction of the commodity, security whether short or long with the help of leverage.  Future contracts or simply futures are traded on futures exchanges like the CME group and it is necessary to have an approved brokerage account to trade the futures. 

Uses of Futures 

Future trading generally have two uses purposes in investing: hedging (managing risk) and speculation. 

Hedging with Futures: Futures contracts that are bought and sold to receive or deliver the commodity for hedging purposes by institutional investors or the companies as a way to manage the future price risk of the commodity on the operations or investment portfolio. 

Speculating with futures: Futures Contracts are liquid and can be bought and sold up to the time of expiry. It is an important feature for speculative investors and traders who do not own the underlying commodity nor wish to. One can buy or sell futures to express an opinion about and potentially from the direction of the market for a commodity. Before the expiry, they will buy or sell the offsetting futures contract position to eliminate any obligation to the actual commodity.

Features of the futures contracts

As we now understand how futures work here are some features of the futures contract: 

In India Commodity futures markets are regulated by the Forward Market Commission. This body regulates aspects such as withdrawing or granting recognition of any commodity markets that are engaged in forward dealings. 

A future contract can work across exchanges, commodities or currencies, and indices. 

A futures contract is standardized, unlike the forward contract. Future contracts allow a hedge to shift the risk towards the speculators. 

Traders also get an efficient idea of what the futures prices of a stock or the value of the index are likely to become. 

The futures contracts determine the future supply and the demand of the shares which will be based on the current future price.

Since the futures are traded on the margin trading they allow those without sufficient funds to carry and participate in trades. One can also pay smaller margins than the entire value of the physical holdings. 

The future contracts are employed by two market participants: Speculators and hedgers. Those who produce or purchase the underlying hedge are known as the producers or purchases. The individuals also guarantee the price at which the commodity will be sold. 

How do futures work? 

Futures contracts allow the players to secure a specified price and protect against the possibility of the wild price swings ahead. We will illustrate an example of an automobile company and a spare parts company. 

An automobile company that is wanting to lock spare part prices to avoid an unexpected increase could buy a futures contract agreeing to buy a set amount of the spare parts in the future at a specified price. 

The spare part company may sell futures contracts to ensure it has a steady market to protect against the unexpected decline in the prices. 

Here both the parties are hedgers, the real companies that need to trade commodities because it is their business. They use the futures market to manage their exposure to the risk of the changes in pricing. But not always in the futures market wants to exchange the product. These people are futures investors or speculators who seek to make money off the prices changes in the contract itself. These traders can buy and sell the futures with no intention of taking the delivery of the underlying commodity. They are in the market to wage the price movements. 

How to trade futures? 

It is easier to trade futures, all you have to do is open an account with the broker that supports the markets you want to trade-in. The futures broker that supports the market is likely to ask about the experience with investing the income and net worth. The questions are designed to determine the risk a broker will take on with margins and the positions. 

There is no industry standard for commissions and fees structures in online share trading. Every broker provides varying services. Some brokers provide in-depth research and advice while others simply give a quote and chart. You can also practice with paper money before committing to real dollars to the first trade. So if you are just starting we recommend spending some time trading in a virtual account. Many of the time experienced investors also use a virtual trading account to test a new strategy.