What Is Meant by Future Trade in Stock Markets?
When you buy shares in the stock market, you hope prices will appreciate over time. Some will try to pick stocks that will outperform an index such as the Dow Jones Industrial Average. Others will attempt to profit from trading futures on the stock or index.
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Features
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A future trade has multiple features that include a buyer, a seller, assets and an agreement. There must be a holder of an asset who wishes to sell at a future date. Next, a buyer needs to agree to take possession of the asset at a future date for a specified price. The seller now has a set contract to deliver the shares to the buyer for a set price.
Profits
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The seller of the agreement has a locked-in contract. His amount of revenue and profit are locked in. The buyer of the agreement knows the price he needs to pay at the future date. If share prices drop, his profit will follow. If share prices rise, he gains the difference between the current value and the contract price.
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Benefits
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The asset holder who sells a futures contract benefits by having a guaranteed selling price. The buyer of the future trade is benefited with high leveraging power for this speculative transaction. Futures trading also allows for hedging against a falling market. This can be achieved by selling future contracts. Also, future trade contracts do not experience time decay like options contracts.
History
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The Chicago Board of Trade created the world's first futures exchange in 1848. The first forward contract was recorded three years later. In 1865 the contracts were standardized and named "futures." The contacts were based on grain trading. Before 1848, farmers would bring their grain to the markets without a future trade contract. Having a market based on immediate supply and demand created problems. Without knowing the potential market, it was difficult to grow the correct amount of grain to exactly meet everyone's needs.
Standardization
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Futures contracts are standardized to create a highly liquid market. Some of the specifications are description of the underlying asset, the quoted currency rate, whether the contract is settled by cash or by asset, the amount of the underlying asset being traded, the delivery date and the final trading date.
Warning
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Unstable economies create volatile markets. This effect is amplified by trading on margin, such as futures contracts. While profits can be quickly made when the underlying asset moves up, you can rapidly lose money when prices drop. A futures trader should never forget that the contract is based on the value of the underlying asset.
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References
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