Futures contracts allow traders to buy or sell a commodity at a specific price on a specific date in the future. Originally, futures contracts were developed so farmers can sell their crop at a predictable price. However, since their initial introduction, the futures market has undergone some major changes. Today, futures contracts are traded by a wide variety of individuals, all around the world.

Futures contracts come in many different forms. Beyond ordinary agricultural products (wheat, cotton, corn, etc.), futures contracts are used for many commodities with highly volatile prices. Gold and petroleum contracts, for example, are among the most commonly traded. Futures contracts can also be used in the stock market. [url=https://www.marketwatch.com/investing/future/sp%20500%20futures]S&P 500 index futures[/url] are in demand during both bullish and bearish market conditions.

There are quite a few reasons a trader might consider purchasing a futures contract. In many cases, these contracts are used to help hedge the risk of another position. They can be used to reduce the risk of holding certain contracts long-term. By having the right to buy or sell at a specific price, you can eliminate the risk of certain price movements unfolding over time.

While the futures market can be quite lucrative, it also presents its fair share of risks. Without a full understanding of the market as a whole, you’ll quickly find yourself losing money. In this article, we will discuss the most important things to know about developing a futures trading strategy. By familiarizing yourself with the market and doing your research, you can become a successful futures trader.

Getting to Know the Futures Contract Market

As suggested, futures contracts are contracts that allow people to buy or sell something at a specific price at some predetermined date in the future. For example, suppose crude oil is currently trading for $60 per barrel. A futures contract could give you the obligation to purchase a barrel of oil for $55 in exactly one year. Whether the price of crude oil, at that time, is above, below, or at the $55 mark will determine how much the contract is worth on its expiration date.

In the above example, having the right to buy at oil at $55 will have a theoretical negative value if crude oil is trading for less than that price. When this happens, a contract is considered “out of the money.” If the price of oil is $60 per barrel, the contract will be “at the money” and if the price of oil is above $60 per barrel, the contract will be in the money. Futures traders—regardless of their long-term goals—are all hoping to purchase contracts that end up in the money at some point in time.

Having the right to buy oil at $55 when the market is demanding $65 will—when all else is equal and trading costs are ignored—be worth $10 per contract on the expiration date. However, as the expiration date (which may be years in the future) approaches, the value of these contracts will continue to change. Sometimes they will be worth pursuing and other times they will not be worth their costs. The key to developing a successful futures trading strategy is being able to identify which contracts are a good deal.

What are the benefits and purposes of trading futures contracts?

As you can see, futures contracts, like all contracts, have both benefits and risks attached to them. Generally speaking, futures contracts can serve two primary purposes: hedging and speculation.

Hedging involves purchasing futures contracts in order to reduce the risk of your current positions. A farmer might engage in futures contracts giving him the right to sell a bushel of corn at a price of $3.50. While the farmer can lose out on potential profits in the event that corn is worth more than $3.50, the benefit of protecting himself from a bad season is worth the initial cost. Even if corn drops to $3 per bushel, the farmer will still collect $3.50 per bushel. This practice can be applied to stocks, index funds, and other securities as well. Hedgers decrease their exposure to risk in exchange for limiting their potential profits.

On the other hand, speculative futures trading involves identifying which contracts are most likely to increase in value. Speculative traders will purchase these contracts—rarely with the intention of holding them to expiration—and treat the contracts the same as some traders treat stocks. If a futures contract is valued at $10 in the status quo, but a speculative trader believes it may be worth $15 in the future, the trader can purchase these contracts and hold them until the value increases. In order to better understand the market, these traders will use many of the same fundamental and technical analysis tools used by stock traders. However, unlike stocks, future contracts have specific expiration dates—this can often make the valuation process a bit more difficult.

What are the risks of trading futures contracts?

Futures contracts are not without their fair share of risks. Both speculative and hedging futures strategies have notable drawbacks.

The most obvious risk of purchasing hedging contracts is that you are limiting the amount of money you can potentially earn. No matter what the prices on your contracts might be, if the market surpasses these prices, you will eventually stop benefiting. Being forced to sell oil at $60 per barrel can be rather depressing if the market is demanding $100 (someone else will earn an easy $40).

For speculators, the primary risk of trading futures is that it is very easy to be wrong. As is the case with stocks, the value of a futures contract can dramatically change. Never assume that you have a “magic touch” that enables you to identify mispriced assets on your own. Furthermore, securities contracts all end on predetermined dates. Unlike stocks, you cannot hold these contracts and hope things get better. You may end up being forced to accept a losing position.

The Keys to Developing a Futures Trading Strategy

Futures trading is not too different from ordinary (presumably stock) trading, though you will need to take the time to develop a specific strategy. When finding a strategy that works for you, keep the following things in mind:

Diversify: don’t go all in on any single contract. Diversify markets, contract lengths, contract size, preferred markets, and other driving factors.

Two-Pronged Approach: hedging and speculating are not mutually exclusive strategies. Consider using both approaches in order to build a combination of security and growth.

Swing Trade: futures trading is often most compatible with swing trading strategies. These strategies involve holding contracts for several days to several weeks.

Technical Analysis: using candlestick charts and future-adjusted technical indicators will make it easier to identify fruitful positions.

Additionally, you will want to be sure to practice on paper as much as you can. Becoming a successful trader is not an overnight process.

Conclusion

The futures market is one that can be incredibly lucrative for traders. Futures contracts can be used for hedging, speculating, or any combination thereof. If you are able to apply these principles and take the time needed to understand the market, you can achieve your trading goals.

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Hi, nice post.

Futures trading is new to the cryptocurrency space and I still find it difficult to wrap my head around it.


Maybe if you trade cryptocurrencies you'd be able to relate better with my confusion.

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The confusing thing is that it seems straight to the point but I still don't get.


I have to go and test it.

Thank you for this post.