Market Basics: What is a Future?

Market Basics: What is a Future?

A future is a type of security that grants the trader the right to buy or sell something at a fixed price on a specific day in the future. That something is normally a commodity like gold, corn, crude oil, bonds, international currencies, or major market stock indices. Futures prices are derived from cash markets which is why they are called a derivative.

Futures are traded by three main groups of traders:

The first is large commercial traders who buy and sell futures to hedge and lock in prices for commodities they produce to use in their operations. Someone who grows coffee might want to lock in a high price at harvest time by selling a futures contract, and Starbucks might want to hedge their costs at lower prices to better manage their budgets and expenses by buying a futures contract.

Large speculative traders are the second group of futures market participants – trading on the direction of prices. Commodity trading pools are an example of a large futures speculator.

Small speculators are the third group, retail traders like you, also trading on the direction of prices.

Futures are traded on various exchanges throughout the United States and internationally, the largest of these exchanges is the Chicago Mercantile Exchange (CME). As a retail trader, keep in mind most futures markets are dominated by the commercial traders, accounting for 75 to 90 percent of all futures trading volume. Futures are generally traded in a separate futures account with a futures broker dealer.

Each futures contract has unique contract specifications, it is important you research the specifics of each market you want to trade. Each futures contract has an expiration date of when buyers and sellers must notify the exchange if they are going to take delivery of the commodity represented by the futures contract.

To trade any futures contract, traders are required to put up a good faith deposit called margin, which sets aside money in your account in the event of losses. For example, to trade one crude oil contract would require $5,000 of margin in order to control 1000 barrels of crude oil. A crude oil futures contract represents 1000 barrels of crude oil which has a value of approximately $60,000 (1000 X $60 per barrel). Each full 1-point move is $1000 profit or loss per crude oil contract. Day traders who do not hold their position overnight get a reduced margin rate of 12.5 to 25 percent of the overnight rate.

Learning which futures to buy or sell and when to buy or sell, when to hold your position and when to close your position requires knowledge and experience you can gain through education and coaching.

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