Futures trading is a way to make money through buying and selling assets at a future date. Traders buy and sell at a set price on a specific day.
If you expect the stock market to rise in value by a certain date, you can enter a futures contract with someone who expects the market to be lower. If the person you have made this agreement with turns out to be correct, then you lose money as they sell their asset for more than what was originally agreed upon. If they are wrong, then you receive higher returns than expected. This risk is balanced with the reward of knowing that you will make more money if your expectations turn out accurate.
How does it work?
The futures markets are started by people who want to buy or sell assets that cost too much or expect the prices to change.
When someone agrees to buy something at a future date, we say they entered into a contract with an open-term order. If someone wants to sell something off in the future, we call this a close-term or short order contract.
Do you have to own it?
It is also possible to trade futures without owning the asset through storage spaces at the time of purchase. For example, if I want to buy Silver but expect its price to rise, I can contract for future Silver and then rent some warehouse space somewhere else. Now that I have future Silver, if the market value rises as predicted, then I can claim that I now own it even though it is currently stored away at another location.
If someone wants to protect themselves from an expected change in prices on something they already own (such as oil), they may enter into a contract with a stop-limit order. It allows them to set a minimum value for the contract and only activate the market value below this predetermined amount.
As futures contracts are linked with other assets, price changes affect each other. For example, if someone puts out a stop-limit order on their oil futures, they are protecting themselves from falling prices and any rise in prices that would make them lose money on their investment. Therefore these two assets are closely linked together as one affects the other.
The main difference between futures trading and other types of investments is the extent to which you can control the market. With cash markets, price changes are unpredictable, so setting up a plan for your money can be challenging. However, with futures markets, you choose the time, value and type of asset that will change and how long you want this contract to last.
For example, if someone wants to invest in gold, they might buy physical coins or digital tokens on a website such as Coinbase. It allows them only to invest once and then wait for it to increase in value over time.
Suppose a large corporation was looking into future investment strategies on gold. In that case, they may choose to go through an intermediary broker, who would have already entered into contracts and collected customers investments. It would allow them to divide and balance their money better before taking action into the market and only paying a single fee for this brokerage service.
On the other hand, if someone was looking for short term investments (for example, they will need cash in one month), then gold may not be appropriate as its value can fluctuate. They might choose to go through an intermediary broker who would have already entered into futures contracts and collected customers’ investments so that they do not have to worry about losing any of their investment immediately, but at the cost of high service fees.
In closing
Although future markets offer stability and predictability, which makes it easier than typical asset trading, risks are still involved, such as unexpected political changes. For example, Brexit was unexpected, so many contracts failed to take the changes in the market into account.
For the best chance of success when trading futures, contact a reputable broker like Saxo.