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 General Trading: What is Futures Trading and How Do You Learn it?

Experienced investors, hoping to expand their horizons into other trading markets, typically approach futures, options, commodities, and currencies as other markets for consideration. All of these areas entail high risk and are not meant for everyone, but with specialized training, practice trading, and the guidance from a professional, these differing trading genres can offer rewards to those that invest the time to learn their unique nuances. The trading in futures contracts is one arena that has been with us since the nineteenth century.

The futures market today is global, but it was originally conceived as a financial device to protect both farmers and their merchant partners from the ravages of over production or scarcity. In the mid-1800’s, central grain markets were created so that farmer’s could sell their crops either on the cash (“Spot”) market or by committing to future delivery date, known then as a forward contract. These contracts were eventually converted to standardized instruments that could be traded on an exchange, thereby enhancing the financial hedging tool and adding speculators to the mix to ensure liquidity and reasonable pricing spreads.

A futures contract is an agreement between a buyer and a seller to deliver and accept a specified underlying asset at a standardized quantity and quality at a specified price on a specific delivery date. These contracts are traded on a futures exchange, and their values vary based on the prevailing conditions in the market. As the contract nears its individual delivery date, its value approaches the actual “spot” market value, such that buyers never actually take delivery of the underlying assets, which are sold to the actual buyer in the market that needs them. Commodities are the primary underlying assets, but they can also range from currencies and securities to other financial instruments, as well.

Exchanges were established to minimize counter-party risk, and for this reason, buyers and sellers are required to post margin accounts. Your respective futures account is debited or credited with each day’s net value change activity. Unlike options where your risk may be limited to a premium amount, futures contract values can fluctuate on a wide basis daily, depending on events like the weather or currency changes in a distant marketplace. Each day’s profit or loss is posted to your account, a process called “marking to market”. Margin calls are a possibility in this trading medium if your account balance is not sufficient to fund your financial responsibility.

New investors to this market are encouraged to locate a competent broker, learn from his tutorials, and then paper trade to gain experience with how the market operates. You can manage your own account, have another professional mange it for you, or join a “commodity pool” to minimize your risk and bring diversification to the process. By either of these routes, the strategies follow the familiar tactics of going long, going short, or locking in a spread with a series of transactions. However, due to the high-risk profile involved, it is highly advised that only risk capital, which you can afford to lose, be devoted solely to this investing activity.

The futures market today is a globally connected marketplace. Farmers in the United States can electronically match a bid from a European buyer. This international forum supports farmers, exporters, importers, manufacturers, and speculators, including both the institutional investor, as well as the retail trader like yourself.

Trading in futures contracts can be complicated and involve high risk. If you have an interest, be sure to discuss it with your investment advisor and broker.

About the Author:

Sara Mackey