{"id":4513,"date":"2021-10-04T23:51:26","date_gmt":"2021-10-04T23:51:26","guid":{"rendered":"https:\/\/mdfinancialskills.org\/?p=4513"},"modified":"2023-06-05T17:42:46","modified_gmt":"2023-06-05T17:42:46","slug":"futures-trading","status":"publish","type":"post","link":"https:\/\/mdfinancialskills.org\/futures-trading\/","title":{"rendered":"Introduction to futures trading"},"content":{"rendered":"\n<p>The broadly defined futures market is a market of nearly impossible scope. You can trade future contracts for just about anything &#8212; any number of currencies, commodities like wheat or corn, livestock like lean hogs, stock market indices, bitcoin, crude oil, even next year\u2019s average temperatures in certain cities.&nbsp;<\/p>\n\n\n\n<p>That\u2019s right, you can buy and sell financial instruments that base their value on the upcoming weather.<\/p>\n\n\n\n<p>Futures trading has a niche for just about everyone.&nbsp;<\/p>\n\n\n\n<p>If you\u2019ve got a trick knee that throbs before a cold spell, a keen nose for the bacon market, or impeccable intuition for the future worldwide demand for wool, you can make money in the futures market.&nbsp;<\/p>\n\n\n\n<p>Be forewarned, however, the futures market entails significant risk and is not suitable for all investors. Make absolutely certain you understand both the financial instrument itself and the underlying asset before you begin trading.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_64 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<p class=\"ez-toc-title\">Table of Contents<\/p>\n<label for=\"ez-toc-cssicon-toggle-item-662c938a9a99d\" class=\"ez-toc-cssicon-toggle-label\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/label><input type=\"checkbox\"  id=\"ez-toc-cssicon-toggle-item-662c938a9a99d\" checked aria-label=\"Toggle\" \/><nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Quick_and_dirty_definition\" title=\"Quick and dirty definition&nbsp;\">Quick and dirty definition&nbsp;<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Futures_trading_in_practice\" title=\"Futures trading in practice\">Futures trading in practice<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Types_of_futures_traders\" title=\"Types of futures traders\">Types of futures traders<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Advantages_to_trading_futures\" title=\"Advantages to trading futures\">Advantages to trading futures<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Risks_to_trading_futures\" title=\"Risks to trading futures\">Risks to trading futures<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#How_to_get_started_trading_futures\" title=\"How to get started trading futures\">How to get started trading futures<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Futures_regulation\" title=\"Futures regulation\">Futures regulation<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/#Further_research\" title=\"Further research\">Further research<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Quick_and_dirty_definition\"><\/span>Quick and dirty definition&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Futures are financial contracts that obligate the holder to buy a product at a specific date in the future at a specific price that\u2019s set today.<\/p>\n\n\n\n<p>Here\u2019s a silly but accurate example: Let\u2019s \u201cpretend\u201d I\u2019m a fan of one of football\u2019s worst teams, the New York Jets. I am planning to go to a game next year when I\u2019m in New York, but tickets are not yet on sale for next season. I\u2019m a cockeyed optimist and I think the Jets will win the Super Bowl this year which will send ticket prices skyrocketing.&nbsp;<\/p>\n\n\n\n<p>To protect my future bank account, I want to lock in a price today, while the Jets are still on the cusp of greatness, but not quite there yet. My friend Steve is a Jets fan who has two season tickets at a current rate of $80 per seat, but the Jets have been such a letdown that he usually tries to sell them. I can make a futures contract with Steve stating that when he receives his tickets for that game, I will buy them for $100 each.&nbsp;<\/p>\n\n\n\n<p>That\u2019s a futures contract.&nbsp;<\/p>\n\n\n\n<p>Steve is betting that ticket prices will stay the same or decrease, and I\u2019m betting that ticket prices will rise.<\/p>\n\n\n\n<p>If I\u2019m right, and ticket prices double after a Jets Super Bowl triumph, I just made a great deal because I have $160 seats for $100. If Steve is right and the Jets remain stuck in their decades-long morass and ticket prices remain unchanged, he made a good deal and I should have waited.&nbsp;<\/p>\n\n\n\n<p>You can substitute corn, bitcoin, cattle or anything else for the Jets tickets and get an idea of how futures contracts work.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Futures_trading_in_practice\"><\/span>Futures trading in practice<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Of course, when you trade futures in real life, you won\u2019t need to find a Steve who has the opposite opinion of the future price of something. Exchanges such as the Chicago Mercantile Exchange list standardized contracts for different commodities and you can simply buy or sell through a brokerage account.<\/p>\n\n\n\n<p>In most cases, you are actually buying directly from the exchange, as they momentarily buy the contracts from the person who wants to sell them and hold them just long enough to sell them to you. This eliminates any risk to the trader that the seller won\u2019t follow through on the sale or the buyer won\u2019t produce the necessary funds.&nbsp;<\/p>\n\n\n\n<p>Exchanges further ease the process by providing uniformity to futures contracts so that you don\u2019t have to haggle over exactly how many bushels of wheat or other commodity or asset will be included in each contract, or determine when the contract will be settled.&nbsp;<\/p>\n\n\n\n<p>For example, soybeans are a typical commodity for which you can buy a futures contract on the Chicago Mercantile Exchange. Each contract sold is for 5,000 bushels of soybeans to be delivered at a specified date.<\/p>\n\n\n\n<p>Keep in mind that with a futures trade, actual delivery of the underlying commodity will happen if you don\u2019t unwind your position. If you buy one soybeans contract and unless you sell the contract before delivery, you will actually receive 5,000 bushels of soybeans! I\u2019m not even exactly sure how much a bushel is, but that seems like a lot of soybeans to store in your garage.<\/p>\n\n\n\n<p>More than 97% of futures contracts are settled before any physical delivery takes place and the vast majority of those who take futures positions only want to profit off the changing price of the contract rather than physically receiving and reselling any sort of commodity.&nbsp;&nbsp;<\/p>\n\n\n\n<p>The value of your futures contract will change as the price of the commodity fluctuates. If a drought wipes out a lot of soybeans and if the price of the remaining crops rise, your contract itself will have value because you have the right to purchase soybeans at the lower price. You can then sell this contract to realize your profit.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Types_of_futures_traders\"><\/span>Types of futures traders<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Generally speaking, people who trade futures fall into two categories. There are the hedgers and the speculators.<\/p>\n\n\n\n<p>Hedgers are those who try to protect themselves from market risk. For example, if you are a farmer and you are worried that the price of corn is going to go down before you bring your corn to market, you could buy futures contracts to lock in what that price will be. That eliminates the risk of the price falling and also eliminates any uncertainty. You know exactly how much you\u2019ll make.<\/p>\n\n\n\n<p>You can hedge your risk for anything that you can find futures contracts for. If you are an importer\/exporter like the famous Mr. Art Vandelay, you might have significant currency risk. You can buy forex futures to lock in an exchange rate today.<\/p>\n\n\n\n<p>Hedging eliminates or mitigates risk, and futures are excellent in that capacity.<\/p>\n\n\n\n<p>On the other side, there are the speculators. They are the ones willing to take on that risk, in the hopes of getting a financial reward.&nbsp;<\/p>\n\n\n\n<p>Speculators believe an underlying security or underlying commodity will rise or fall in price and so they buy or sell futures in order to profit on their belief.&nbsp;&nbsp;<\/p>\n\n\n\n<p>In our Jets example above, I was hedging &#8212; trying to eliminate the risk that Jets ticket prices would go up and Steve was speculating &#8212; he was trying to profit because he believed prices would actually stay the same or decrease.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Advantages_to_trading_futures\"><\/span>Advantages to trading futures<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Why trade futures? One of the biggest advantages of futures trading is that you get to take direct positions in commodities and assets you\u2019d never be able to access if you just bought and sold individual stocks on the stock market. As I\u2019ve already mentioned, you can profit off the weather, meat prices, fruit prices, crypto currency prices \u2026 the list is endless.&nbsp;<\/p>\n\n\n\n<p>The other great advantage to trading futures is that you can buy on margin. Buying on margin means that you don\u2019t pay for the full value of the contracts you are purchasing.&nbsp;<\/p>\n\n\n\n<p>For example, let\u2019s say a bushel of soybeans goes for $10, which means one futures contract would be worth $50,000 of soybeans (each contract is 5,000 bushels if you recall). The percentage varies depending on the commodity, but typically you only have to put down 2%-12% of that $50,000 as an initial margin requirement. For simplicity&#8217;s sake, let\u2019s say the initial margin requirement is 10% for soybeans, so you only need to put down $5,000 for a futures contract for $50,000 worth of soybeans.&nbsp;<\/p>\n\n\n\n<p>That, my friends, is what\u2019s known as leverage. You can take very large positions for very little cash.&nbsp;<\/p>\n\n\n\n<p>It is not <em>quite<\/em> that simple, however. There\u2019s also a maintenance margin requirement. After the initial margin requirement is taken from your account to be held as a deposit, your account still must meet maintenance margin requirements. This amount depends on a number of factors, but in our soybean example, let\u2019s assume the maintenance margin requirement is an additional $5,000. That means the value of your account must stay above $5,000 at all times.&nbsp;<\/p>\n\n\n\n<p>If your soybeans contract (or other positions you may have) loses enough money so that your account balance falls below $5000, you must deposit additional cash into your account or sell your position. This is the dreaded \u201cmargin call.\u201d<\/p>\n\n\n\n<p>If you don\u2019t have enough money to meet your margin requirements, you could be forced to liquidate your position or other positions at a loss.&nbsp;<\/p>\n\n\n\n<p>Leverage is a double-edged sword. Yes, it can multiply your profits and make you a very rich trader. It can also multiply your losses, which leads us to &#8230;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Risks_to_trading_futures\"><\/span>Risks to trading futures<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>With great leverage comes great responsibility. Do not trade futures without understanding the significant risk.<\/p>\n\n\n\n<p>With a 10% initial margin requirement, you are leveraged 10:1. That means a 10% drop in prices would lead to a 100% loss of your investment. If you can\u2019t make your margin calls, you\u2019ll have to liquidate and you\u2019ll lose it all.<\/p>\n\n\n\n<p>And it could get worse.<\/p>\n\n\n\n<p>In a worst-case scenario, you can lose even more than you invested. A crash in the underlying market or commodity for which you have a futures contract could leave you in debt to your broker if you don\u2019t get out in time.&nbsp;<\/p>\n\n\n\n<p>One bad futures trade can be a financial disaster, so proceed with caution. Do a very honest assessment of your risk tolerance before making any futures transactions.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"How_to_get_started_trading_futures\"><\/span>How to get started trading futures<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>You can trade futures with a number of different brokerages, although you will be subject to minimum account balances and many brokerages will also perform credit checks and try to assess your risk tolerance and familiarity with futures.<\/p>\n\n\n\n<p>Many brokerages and even some exchanges offer the chance to \u201cpaper trade\u201d or make practice trades with a virtual account. This is an excellent opportunity to get familiar with the mechanics of a particular trading platform, learn how to read quotes, and test out your trading strategy. I strongly suggest you take this opportunity.&nbsp;&nbsp;<\/p>\n\n\n\n<p>I\u2019ll be publishing my reviews of different futures brokers in the near future, please check back. I promise I won\u2019t mention the Jets again.<\/p>\n\n\n\n<p>Another way to access the futures market is through proprietary trading companies &#8212; something you can learn about here.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Futures_regulation\"><\/span>Futures regulation<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Since futures trading can be quite complex and entails risks that can go far beyond simple stock trading, there are substantial opportunities for unscrupulous brokers and fund managers to try and take advantage of newcomers to the futures market.<\/p>\n\n\n\n<p>Fortunately, there are several regulatory bodies that protect both individual investors and futures markets in general. The Commodity Futures Trading Commission (CFTC) regulates the industry as a whole, provides market data, and is a great overall resource for anything regarding futures markets.<\/p>\n\n\n\n<p>The<a href=\"https:\/\/www.nfa.futures.org\/members\/index.html#ORS\" target=\"_blank\" rel=\"noopener\"> National Futures Association (NFA) maintains a database<\/a> of registered futures traders and brokers. If you\u2019re receiving investment advice about futures accounts or are considering investing with a commodity pool operator (CPO), make sure the broker\/advisor is registered with the NFA.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Further_research\"><\/span>Further research<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Watch \u201cTrading Places\u201d with Eddie Murphy and Dan Aykroyd. Seriously. First off, it is hilarious. Eddie Murphy is at his best. Secondly, the depiction of futures trading is realistic enough that the movie is on the curriculum in futures and options classes at some of the top business schools in the country.&nbsp;<\/p>\n\n\n\n<p>You should definitely do a little more research beyond this movie before you start trading futures, but it is a hilarious introduction to the lives of futures traders and it even has a lesson or two about formulating a trading strategy and taking advantage of market volatility.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The broadly defined futures market is a market of nearly impossible scope. You can trade future contracts for just about anything &#8212; any number of currencies, commodities like wheat or corn, livestock like lean hogs, stock market indices, bitcoin, crude oil, even next year\u2019s average temperatures in certain cities.&nbsp; That\u2019s right, you can buy and &#8230; <a title=\"Introduction to futures trading\" class=\"read-more\" href=\"https:\/\/mdfinancialskills.org\/futures-trading\/\" aria-label=\"Read more about Introduction to futures trading\">Read more<\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[9],"tags":[],"featured_image_urls":{"full":"","thumbnail":"","medium":"","medium_large":"","large":"","1536x1536":"","2048x2048":""},"post_excerpt_stackable":"<p>The broadly defined futures market is a market of nearly impossible scope. You can trade future contracts for just about anything &#8212; any number of currencies, commodities like wheat or corn, livestock like lean hogs, stock market indices, bitcoin, crude oil, even next year\u2019s average temperatures in certain cities.&nbsp; That\u2019s right, you can buy and sell financial instruments that base their value on the upcoming weather. Futures trading has a niche for just about everyone.&nbsp; If you\u2019ve got a trick knee that throbs before a cold spell, a keen nose for the bacon market, or impeccable intuition for the future&hellip;<\/p>\n","category_list":"<a href=\"https:\/\/mdfinancialskills.org\/category\/trading\/\" rel=\"category tag\">Trading<\/a>","author_info":{"name":"Michael","url":"https:\/\/mdfinancialskills.org\/author\/leigh\/"},"comments_num":"0 comments","featured_image_urls_v2":{"full":"","thumbnail":"","medium":"","medium_large":"","large":"","1536x1536":"","2048x2048":""},"post_excerpt_stackable_v2":"<p>The broadly defined futures market is a market of nearly impossible scope. You can trade future contracts for just about anything &#8212; any number of currencies, commodities like wheat or corn, livestock like lean hogs, stock market indices, bitcoin, crude oil, even next year\u2019s average temperatures in certain cities.&nbsp; That\u2019s right, you can buy and sell financial instruments that base their value on the upcoming weather. Futures trading has a niche for just about everyone.&nbsp; If you\u2019ve got a trick knee that throbs before a cold spell, a keen nose for the bacon market, or impeccable intuition for the future&hellip;<\/p>\n","category_list_v2":"<a href=\"https:\/\/mdfinancialskills.org\/category\/trading\/\" rel=\"category tag\">Trading<\/a>","author_info_v2":{"name":"Michael","url":"https:\/\/mdfinancialskills.org\/author\/leigh\/"},"comments_num_v2":"0 comments","_links":{"self":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts\/4513"}],"collection":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/comments?post=4513"}],"version-history":[{"count":1,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts\/4513\/revisions"}],"predecessor-version":[{"id":6020,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/posts\/4513\/revisions\/6020"}],"wp:attachment":[{"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/media?parent=4513"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/categories?post=4513"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mdfinancialskills.org\/wp-json\/wp\/v2\/tags?post=4513"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}