About Futures Trading

Futures trading allows investors to speculate in or hedge their exposure to commodities, interest rates, stock indices and other financial securities on the future price of commodities. It also allows producers to lock in prices for the goods they are making or buying. It occurs on futures markets around the world.

History

It is not known exactly when futures trading started. One of the first documented systems of futures trading was in China about 6,000 years ago when a futures market was used for the rice industry. Futures markets have been used continuously since that time. An exact start of futures trading in the United States is hard to precisely pinpoint due to definitional differences between forward contracts, futures contracts and futures trading. However, by 1877 the Chicago Board of Trade, the first place futures were traded in the United States, had formalized its futures trading practices and allowed speculators to participate in the process.

Function

The purpose of a futures market is to allow producers of commodities to reduce some of their risk by locking in prices early for the products they are mining, growing or making. For example, in June a wheat farmer can lock in a sales price for their harvest in September and eliminate the risk that prices may fall. However, the farmer will not benefit if prices rise because they have already agreed to a sales price.

Types

The first type of futures trading is the traditional kind, which involves commodities. Commodities are raw materials that can be bought or sold. Examples of commodities are oil, grain, oranges, gold and silver. However, futures trading has expanded and today futures can be traded on things that are not just physical like financial securities and stock indices.

Features

The futures market involves balanced trading. For every buyer there must be a seller. At the end of the trading day the books must be balanced. Delivery of the underlying commodity is required for positions that are not closed out with off-setting trades prior to the future contracts maturity.

Warning

Futures trading is a form of trading that can be used to "get rich quick" because of the ability to use leverage. While futures trading has the potential for great profits it involves great risk. The futures market is extremely volatile and requires an experienced investor with the historical knowledge and current research to make informed decisions. Some futures cannot be traded on the open market and there are "limit down" days where some futures cannot be traded. This can lead to investors getting "stuck" in a bad investment choice. Even experienced investors can lose a fortune trading in commodities where a new discovery, such as a new gold mine, can change the whole market. Potential investors in futures should consult or become an investing expert before entering this market.