Basics of Futures Trading
Trading futures is a method of making a profit by taking a position with a difference between the contract price and the actual price of a commodity. The position can be short, to sell, or long, to buy, the commodity. It is the price difference that is the real value of the futures contract. The essence of futures trading is market changes. Called volatility, prices of commodities can change in ways that are not easy to predict. The tendency of a price to change by an amount that can create a profit is the key to futures trading. It is the way traders make profits.
Trading takes place under the authority of a commodity exchange such as the Chicago Mercantile Exchange. Accessed equally well online or at a physical location, most traders use the Internet to place their contracts and execute closings. The exchanges set rules, control account charges, and set deposit requirements, referred to as margins.
Types of Commodities
Energy is a class that includes crude oil, petroleum fuels like jet fuel, diesel fuel, and gasoline. It also includes heating oils and natural gas. Energy commodities are global since these fuels have world-wide markets. Many traders work in one or a related group of energy commodities such a crude oil and refined petroleum products. Precious metals include the popular ones like gold, silver, and platinum; it also includes metals with largely industrial purposes like copper. Agriculture includes staples like wheat, corn, and soybeans, live animals like cattle, and meat products like pork bellies. Financial commodities include bonds, interest rates, stock indexes, and currencies. These are sometimes faster moving than other commodities. The idea is the same, to use contracts and prices to create a premium with the underlying commodity. Currencies show a great deal of change and even a small change can create a large profit when repeated many times.
The basic techniques are hedging and shorting. These are methods of holding a commodity until the contract price is favorable, or selling a contract early to make a profit and possible buying it back later to make anther profit. The terms involved can be puts and calls, which are buy and sell offers. Other techniques are spreads and straddles which involve picking a price or strike point, setting up a buy and a sell and watching the movement of the commodity to determine whether to take a short or long position.
An important feature of trading on commodity exchanges is leverage. The deposit requirements are low, and that creates an advantage for the trader, as a small deposit can cover the amount of the contract many times greater. For example, a $2,500 deposit might be required on a $25,000 contract. The leverage is ten to one. This feature offers the opportunity to have a large profit if the price moves as predicted, or a large loss if it moves the opposite way. The deposit can be wiped out, and if there is a deficit, it must be covered immediately, though a margin call. Called a naked trading account this method exposes the trader to risks and may not be good for those who do not want to devote the time needed to master details and stay on top of the transactions.
Broker and Low Risk Pool Accounts
For people with less time or expertise, a broker account may work better. A paid expert, the broker, picks the contracts and executes transactions. This arrangement will reduce profit by fees paid, but it may create greater success. A pooled account is a group of investors who contribute funds to a futures trading enterprise. The group distributes profits generated by trading on the basis of the amount paid in by each investor. This arrangement can protect the individuals against margin calls by creating reserves to cover the trading account deposit requirements.