Even if you think you’re relatively well-versed in trading, there’s probably a few aspects of it that you’ve never thought about or have limited knowledge on. Futures trading is one of those things that some financially-minded folks know a lot about and others find to be hard to understand.
Whether you have considered getting into futures or you just want to know a little more, we’ll discuss some of the basics so you can familiarize yourself and make a well-informed decision about this type of trading.
What is Futures Trading?
The answer to this question isn’t quick or short, but if we break it down a bit, we can make it easier to understand. Futures trading (or “Futures”) is a type of investment which involves guessing if the price of a commodity will go up or down in the future.
A commodity can be anything from corn and cotton to oil, aluminum, and even currency. Every day, all over the globe, hundreds of types of commodities are traded between investors resulting in a futures contract.
A futures contract occurs when two parties agree to buy a commodity at a fixed price and a set date in the future (hence, the term “futures”). According to the U.S. Commodity Futures Trading Commission, future contracts helped to make selling (between the farmer and the buyer) legal and fair long before contracts became an aspect of the trading world.
Contracts were created to specify the amount and quality of a commodity and when it would be delivered. Today, the set date on a futures contract can be anywhere from a month to a year (or more or less), and it’s possible to terminate a contract before it expires. Don’t be surprised to hear that some traders only adhere to their contract for a couple of hours.
The Difference Between Assets You Can Trade and Futures
If you don’t know much about futures trading, you may not see a big difference between the assets you can trade and futures contracts. You might even be thinking, “Isn’t trading just trading?” While there are many common aspects, futures are different.
We already mentioned that futures have an expiration date, unlike your stocks which can essentially go on without an end in sight. Another big difference is an investor’s ability to use leverage. Anyone who has ever invested knows that leverage can result in success but can also lead to failure.
Are There Benefits To Futures?
Futures isn’t for everyone, and even though you can bow out of the contract as soon as you want, it still requires some careful consideration; otherwise, you might find yourself scurrying to make money to pay up a balance. We aren’t saying that trading futures are bad, it just may not be the best choice for everyone (much like other aspects of trading).
Here are some of the benefits to consider:
- High Leverage Investments: Futures are high leverage investments which can result in an excellent return.
- Small Margins: In order to get a futures contract you’re only required to put up about 10 percent of the value of the contract. This small margin allows you to trade more of the commodity and possibly make a much larger profit.
- It’s Only in Writing: Unlike the history behind futures contracts, you don’t actually have to deliver the commodity at the expiration date. Futures contracts are paper transactions.
- Commission Charges Cost Less: Not always, but most of the time commissions costs are smaller when using a broker on a futures trading platform than other types of investments. Like all broker fees, the price varies depending on the level of his or her involvement.
Getting Started With Futures
Do you want to know how to trade futures? Before you jump right in and get started, it’s best to take careful consideration when selecting a brokerage firm. If you feel pretty comfortable and confident with your investment skills, hiring a discount broker may be more than enough. These brokers are usually less expensive and let you have a little more control.
Some people have no interest in hiring a broker and go at it alone, which can be riskiest, but with the right knowledge and attention to the market, you might do just fine. If you want and need a lot of advice or you just don’t have much interest in being “hands-on,” you’re better off choosing a full-service broker; keep in mind this will cost you more.
Don’t know who to choose? Ask around, do some research, read peer reviews, make an appointment and ask some questions. The broker you choose should make you feel confident and excited about your future with futures.
Your broker will help you walk through the trading process but familiarize yourself with the market categories before you make a decision. It’s always best to start out with the market categories you know the best (i.e., oil).
Starting Out Simple
If you have no experience with futures, the most basic and simple step you can take is to buy or sell a futures contract. Come up with a strategy, stick to it, monitor it closely, and build on your trading skills as you go.
Know Where To Get Your Information
Whether you’ve hired a broker or not, it’s important to know what’s going on and know where to find pertinent information in regards to your futures contracts. Pay attention to government reports of weather, crop sizes, and even the news (such as catastrophes in other parts of the world).
Many factors can affect the rise and fall of commodities, so you often need to think beyond the stock ticker.
A Few Additional Tips
If you have a good broker on your side, you shouldn’t encounter too many issues but here are a few additional tips to think about:
- Only use money that you can put at “risk.” Not money you use for living expenses.
- Learn and get to know terms like leverage, diversification, after hours market, liquidity, and hedging.
- Even with a broker, you should pay close attention to the market and know when to get in and out.
- As with other trading, watch and follow trends.
- Be patient, be smart, and learn from your mistakes.