Futures contracts dictate the quantity of the prime asset. They’re structured to sustain trading on a futures exchange. Selling a contract is equivalent to shorting a stock in the stock market. Buying is similar to opening an extended position. Before allocating a portion of your portfolio to the futures market, it’s essential to consider the benefits and risks.
Pros (Benefits) of Futures Trading
Active traders can experience a monumental challenge when posting sustainable gains in subpar market conditions. Sluggish prices, trading on low volumes, or market turbulence occasionally prove counterproductive to the bottom line. Luckily, futures markets often supply two crucial components of the success of an active trader:
With intensive knowledge of the futures market, orders are filled efficiently. Thus reducing the subsidence and helping in market entry or exit.
Steady fluctuations in rating the contracts give a regular trading opportunity. Additionally, you’ll be able to realize profits from discrepancies.
In simple terms, your ideal target should exhibit perpetual volatility as well as a high degree of liquidity. Liquidity and volatility are a great advantage of trading futures.
For you to run a successful business, it should be able to take in more money as compared to what’s going out. Profitability is equivalent to total revenue, subtract the operational costs. In the case of an active trader, expenses boils down to two categories: capital loss and sunk costs.
While you’re trading futures, capital losses are inevitable. To deal with the losses, you’ll need to adopt a proactive approach through which you’ll be able to manage your money. However, sunk costs are mild as compared to other types of capital investiture. As a futures trader you must be able to account for:
- Exchange/clearing fees
- Brokerage Commissions
- Data Fees
The symmetry of futures cost structure is that apart from monthly fees to stream exchange based-data, the other expenses are covered on a per-trade basis.
Flexibility and Diversity
In futures markets, traders can engage a wide variety of assets. As a trader, you can achieve this through any methodology. There’s a strategy application flexibility and diversity of the products, which are the blatant benefits of trading futures.
Most active traders are attracted to futures trading due to its flexibility. You enjoy limitless profits from long positions to bear markets. Securing market share from both long and short positions is a significant bonus that is not readily available in standard stock or bond markets. Besides the transaction freedom, you can increase your market exposure through enhanced leverage.
The diversity of product offerings while trading futures is highly advantageous. Through diversity, standardized contracts have a broad spectrum of asset categories. Examples of those that are accessible include energies, metals, equities indices, interest rates, etc. Independent of your asset preference, the associated futures contract remains steady for trade.
Cons of Futures Trading
Futures come with definite expiration dates. Even after establishing fixed prices on the assets on your contract, these prices may become less attractive to others. They may expire as worthless investments. The main challenge you may face while trading in the futures market is knowing what you’re purchasing.
A futures contract has its value, quantity, quality, and the expiration date. You should be aware of when your contract expires to be able to open a position. You may opt to settle your contract by cash or by the actual asset.
Leverage can play as an advantage and as a disadvantage. You can buy a futures contract for a small percentage of the contract’s value. However, leverage, in some instances, may involve the fast movement of futures prices. The prices can tick up or down daily, while some will within some minutes.
If lady luck isn’t smiling on you on any given day, you might receive a margin call from your broker advising you that your account is below minimums. That’ll mean you must transfer more cash to your account immediately.
As a result of markets being open 24 hours a day, the value is continually changing. Therefore, futures day trading will require a lot of time to watch the market. If you aren’t ready to give your time to futures trading, you’re setting yourself up to losing money.
Selling a Futures Contract: Objectives and Benefits
As seen in this article, flexibility is the largest advantage of trading futures. In comparison to the traditional capital investment forms, a futures trader profits from either rising or falling markets. As an investor, you’re not only limited to gain by buying low and selling high, but also selling high and buying low. It’s an effective way of boosting market share.
Reasons for Selling Contract in Futures Trading
Short selling is a trading strategy that is regulated by the decline of the prices of securities or stocks. While you may use short selling as Speculation, portfolio managers use it as a hedge. Here, you can open a position by borrowing shares of a stock or other financial instruments.
Often, trade selling involves selling contracts to exit a long position. Depending on the predetermined strategy, selling a futures contract remains the best option to close out an open long position.
Real World Example of a Contract in Futures Trading
If you watch news, you’ve definitely heard of oil prices going up and down. Oil’s future contracts are the most actively traded. Oil’s demand is high, thus a huge expense for most organisations. Mostly, these huge companies don’t want to encounter the unpredictability of the prices of oil, thus, they purchase futures contracts to be safe should prices go up.
A perfect example of such a scenario was in 2007. Oil prices went from $60 to $140 a barrel. This automatically increased the cost of gasoline.the industry that was hit the hardest was the airline industry. As the prices went up, the profits for airline companies dropped dramatically.
According to The New York Times, Southwest Airlines had loaded up in the previous years of hedges against higher fuel prices. They had bought oil futures with a delivery date of around a year out. The price was slightly higher than the current price. It simply means, when oil was selling at $60 a barrel in 2007 and 2008, Southwest Airlines was buying oil futures at $65. About a year later, the prices soared to around $140, Southwest was making profit on their $65 oil futures contracts.
Involving yourself in the futures market means interacting with the “pro-leagues” of market trading. While futures trading may seem so complicated, it is worth taking time to learn and understand. You can manage the risks of futures. The futures market offers a great deal of potential to make reasonable return rates.