What Is Futures Trading?

As with trading stocks or other financial assets, it’s important for investors to develop a plan for trading futures that outlines entry and exit strategies as well as risk management rules. In order to understand fully what a futures market is, it’s important to understand the basics of futures contracts, the assets traded in these markets. The range of assets underlying futures covers everything from agricultural products to financial indexes. As of early 2024, the most traded futures were in equities (65% of futures trading by volume), currencies (9%), interest rates (9%), energy (5%), agriculture (4%), and metals (4%). These firms are in the business of making speculative trades to benefit directly from market moves. They are significant players in the market because of their aggressive trading tactics, sophisticated technology, and ability to take on substantial risks.

Futures trading commonly refers to futures whose underlying assets are securities in the stock market. These contracts are based on the future value of an individual company’s shares or a stock market index like the S&P 500, Dow Jones Industrial Average, or Nasdaq. Futures trading on exchanges like the Chicago Mercantile Exchange can include underlying “assets” like physical commodities, bonds, or weather events. Individual investors have also grown active in futures, enabled by user-friendly online brokerages.

Ongoing Challenges for Futures Trading

Companies can plan their budgets and protect potential profits against adverse price changes. Investors risk losing more than the initial margin amount because of the leverage used in futures. For example, futures for a major index like the S&P 500 might have contracts expiring in March, June, September, and December. The contract with the nearest expiration date is known as the “front-month” contract, which often has the most trading activity. As a contract nears expiration, traders who want to maintain a position typically roll over to the next available contract month.

Most casual traders don’t want to be obligated to sign for receipt of a trainload of swine when the contract expires and then figure out what to do with it. Investors can also take a short speculative position if they predict the price will fall. If the price declines, the trader will take an offsetting position to close the contract. An investor gains if the underlying asset’s price is below the contract price and loses if the current price is above the contract price. If a trader buys a futures contract and the price rises above the original contract price at expiration, there is a profit. However, the trader could also lose if the commodity’s price was lower than the purchase price specified in the futures contract.

The key difference lies in the obligations they impose on buyers and sellers. Since a futures contract is an obligation in the future, a trader can sell contracts without buying contracts first. Traders who sell more contracts than they buy have a short futures position, while traders who buy more contracts than they sell have a long futures position.

This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. Our partners cannot pay us to guarantee favorable reviews of their products or services. Futures and stock trading have certain things in common, but the former has additional considerations like leverage and also expiry dates. Banking products and services are provided by Morgan Stanley Private Bank, National Association, Member FDIC.

Five reasons why traders use futures

This is mitigated for futures by the exchange clearinghouse, which guarantees the contract. While each side is taking a risk that the price they pay now is close to the actual price at the settlement month, hire the best freelance asp net mvc developers updated daily each party insures against the risk of a wide swing against them in oil prices. NerdWallet, Inc. is an independent publisher and comparison service, not an investment advisor.

Since then, they’ve evolved to include different securities and financial instruments, along with other commodities. Examples of futures markets are the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBoT), the Cboe Options Exchange (Cboe), and the Minneapolis Grain Exchange. Traders should carefully consider their risk tolerance and engage in futures judiciously, employing risk management strategies such as stop-loss orders to protect against significant losses. Currency futures should not be confused with spot forex trading, which is more prevalent among individual traders. A forward contract is the oldest type of these agreements, predating the trading in futures that formalized “to arrive” contracts in the latter half of the 19th century. A forward is an agreement between two parties to transact in the future, with one party taking the long position and the second taking the short position; they are also called the long and short forwards.

How we make money

As an investment tool, futures contracts offer the advantage of price speculation and risk mitigation against potential market downturns. Taking a contrary position when hedging could lead to additional goldman sachs to offer clearing services via lchs forexclear losses if market predictions are off. Also, the daily settlement of futures prices introduces volatility, with the investment’s value changing significantly from one trading session to the next. The buyer of a futures contract must take possession of the underlying stocks or shares at the time of expiration and not before. American-style options give the holder the right, but not the obligation, to buy or sell the underlying asset any time before the expiration date of the contract. The CFTC sets rules for how contracts are traded, including requirements for margin deposits and limits on excessive speculation that would artificially distort prices.

1. Index futures are a way to gain exposure to an entire index in a single contract.
2. Investors, fund managers, and financial institutions use bond futures to protect their portfolios against interest rate changes or to take positions based on their interest rate outlook.
3. These firms are in the business of making speculative trades to benefit directly from market moves.
4. Therefore, this compensation may impact how, where and in what order products appear within listing categories, except where prohibited by law for our mortgage, home equity and other home lending products.

What are futures contracts?

Moving averages plot past average prices to determine critical support or resistance levels and reveal trends that traders can follow or bet against. This kind of trading can be very complex, so it is wise to conduct substantial due diligence before getting involved. It might be a good idea to spend a few months taking part in so-called paper trading so you can test out your strategy without putting money at risk. That is, your plan should factor in if you’re a technical analyst or if you use fundamental analysis in your trading. You may choose to go long or short, or you may decide to use calendar spreads. Whatever you choose, it’s always a good idea to plan your entry and exit strategies and basic risk management rules.

Now that we’ve seen what futures are, let’s explore how they work by defining and illustrating some essential futures terms.

The Financial Industry Regulatory Authority requires a minimum of 25% of the total trade value as the minimum account balance. You can practice trading with “paper money” before you commit real dollars to your first trade. This is an invaluable way to check your understanding of the futures markets and how the markets, leverage and commissions interact with your portfolio. Futures are contracts to buy or sell a specific underlying asset at a future date.

Types of Futures Traders

Most all futures markets are registered with the Commodity Futures Trading Commission (CFTC), the main U.S. body in charge of regulation of futures markets. Exchanges are usually regulated by the nations regulatory body in the country in which they are based. Originally, such trading was carried on through open outcry and the use of hand signals in trading pits, located in financial hubs such as New York, Chicago, and London. Throughout the 21st century, like most other markets, futures exchanges have become mostly electronic. One strategy that speculators use to trade currencies is scalping, which tries to make short-term profits from incremental changes in the value of a currency.

The researchers also found that retail traders often go against market momentum, entering long positions when prices have recently fallen or going short after upward runs. This reveals contrarian thinking for amateurs, hoping prices revert after big upward or downward moves. Futures are contracts where two financial spread betting companies top 10 brokers parties agree to exchange a specific quantity of a commodity or other underlying asset for a predetermined price at a future time. These contracts were initially created to help businesses navigate unexpected costs. Futures are derivative contracts that let you speculate on the future price of some asset or commodity, or to let you hedge against existing positions.