Futures Markets, The Art of Trading with Time

Posted in Investments on February 18th, 2010 No Comments

Futures Markets are very confusing for the beginner in stocks trading. However they provide a great opportunity to make a good profit in today’s volatile markets.

What are Futures Markets?

A Futures Contract is an agreement to purchase or sell a quantity and quality of a commodity, whether physical or financial, for a specific price at a set time in the future. The market consists of physical commodities like gold, soybeans, coffee and oil, and financial commodities like bonds, currencies, indexes, and single stock futures.

Hedgers and Speculators

There are two types of futures traders, hedgers and speculators. These two types are as different to each other as traders can be. Hedgers are generally farmers and manufacturers that actually want to sell or buy the products traded. Farmers use the futures markets to lock the price of a crop and guarantee a minimum profit on their work. Manufacturers use them to guarantee they have the raw materials they need to operate.

It is important to understand that futures prices are a direct result of consumer supply and demand. If a farmer likes the current price of wheat he can sell his crop before it is farmed and lock the price and the current price. Oil companies also do this, to take advantage of high oil prices.

Speculators are a completely different type of trader. They don’t want to buy or sell the commodities. They are out to make a profit off the buying and selling of futures and are not interested in locking prices.

Today most traders in the futures markets are speculators. The idea is to make money on an educated guess of what the prices of commodities or financial commodities will be in the future. For instance if you think corn prices are going to rise you buy, or as it is also called go long in the hope that you can later sell at higher price. If on the other hand, you think prices will drop then you go short, or sell futures for corn three months down the road.

Hedgers and speculators have a very interesting symbiotic relationship. Hedgers look for security while speculators live off risk. Together they keep the futures markets active so that everybody can have a chance of making a profit.

An interesting type of futures trading is that of financial commodities like bonds and currencies. In this case money is the commodity traded. The price of money varies depending on a number of factors like interest rates and the price of reference currencies like the US dollar.

As with all types of trading risk is a serious factor. Although futures can be highly profitable it does require a steep learning curve to understand, and losing money is easy to do. Talk to your financial advisor if you think this might be a good option for your portfolio.