The most common questions about futures trading, answered
Futures trading is a popular way for traders of all experience and skill levels to participate in the financial markets without directly owning an underlying asset. For many traders, it is one of the first derivative trading products they learn about. When they do, they naturally have many questions about how it works and how they can get started trading futures. Below, we have compiled a list of commonly asked questions on futures trading. Designed to equip traders with a comprehensive overview of what futures trading is, this article is a good place to start if you are considering futures trading.
What is futures trading?
Futures trading is a type of investment strategy that involves the buying and selling of standardised contracts. They stipulate delivery of an underlying asset for delivery in the future, such as a stock, commodity, currency, or stock index, at a predetermined price on a predetermined date. As standardised contracts, futures have the same quantity, quality, delivery date, and settlement method.
How does futures trading work?
Futures trading works in a straightforward manner. First, buyers and sellers participate in a contract on an exchange, where they agree to buy or sell an underlying asset at a future date with a predetermined price. Futures contracts are transparent as they are standardised, and buyers and sellers can trade them easily.
Buyers can take a long position or a short position, depending on whether they think the underlying asset will increase or decrease in price. If they believe the asset will increase in price, they will take a long position. Conversely, if they believe the asset will decrease in price, they will take a short position.
When the contract’s delivery date arrives, the buyer must take delivery of the asset they are speculating on, and the seller must deliver the asset. Many contracts, especially those that are traded for the purpose of speculation for monetary profit, are cash-settled, and no physical delivery is arranged to exchange the underlying asset. When settling the contract, the buyer and the seller exchange the difference between the contract-stipulated price and the current market price of the asset.
Where does futures trading take place?
Many traders take part in trading futures online, on organised exchanges. Some of the most established exchanges include the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange (NYMEX), and the Singapore Exchange (SGX).
What impacts the price of a futures contract?
A few factors affect the price of a futures contract, and most of these factors go back to supply and demand dynamics on an exchange. If there is a shortage of an asset, the price of a futures contract is likely to increase. If there is an oversupply, it is likely to fall.
Market sentiment can affect supply and demand. Geopolitical events, economic data, general market outlook, and company news can impact market sentiment, which can cause traders to increase or decrease their trading of futures.
Seasonal factors can also affect supply and demand, particularly for agricultural commodities. Weather patterns and growing cycles can impact the supply of crops such as wheat, soybeans, and coffee, and this can have an impact on their supply.
Interest rates and currency exchange rates likewise can impact the price of a futures contract. Higher interest rates can affect the cost of financing for the underlying asset, while a higher currency exchange rate may mean that traders will find it more expensive to purchase a contract denominated in a different currency than their home currency. Both of this can affect the demand for contracts.
What underlying assets can be traded with futures?
Futures trading is incredibly versatile, and underlying assets that can be traded with them include commodities, currencies, stock indices, interest rates, bonds, and more. However, the availability of futures contracts for a particular asset class will depend on the broker you work with, so you should choose a broker that offers what you want to speculate on.
The most common instruments in these asset classes include agricultural products such as corn, wheat, soybeans, and coffee, energy products such as oil and gas, and metals such as gold and silver. Major currencies such as the US dollar, British pound, Japanese yen, and Swiss franc are also popular choices. Stock indices futures allow traders to speculate on the stock market in a broad way, and some popular options include the S&P 500 and the NASDAQ 100.
How do I choose a futures broker?
Choosing a futures broker can be done by considering the following: the broker’s regulation, the trading platform offered, margin requirements, commissions and fee structures, educational resources, and the asset classes available for trading.
In Singapore, the ICE (Intercontinental Exchange) Futures Singapore manages, monitors, and regulates all trading activities in the country’s futures markets. If you are selecting a futures broker, be sure that it is regulated by the ICE and licensed and governed under the Securities and Futures Act (SFA).
What are the benefits of trading futures?
Trading futures can offer several benefits, ranging from the use of leverage, the potential for profit, transparency, ease of diversification, and high liquidity for certain instruments.
Futures trading is leveraged, meaning traders can control a much larger position than they would otherwise be able to in non-leveraged trading if they had a relatively small investment. Leveraged trading is one way for traders to magnify potential profits. However, it can also magnify potential losses, and traders must be careful not to use high leverage if they have a low appetite for risk.
As futures can be traded on many underlying assets, it is also a good way for traders to diversify their existing portfolios. Diversification can lower the overall risk of a trader’s investments.
Futures contracts are standardised and exchange-traded, so there is a high level of transparency in its pricing and exchange. They are easy for traders to trade, and there are clear and well-defined regulations that brokers and traders must follow.
Finally, the futures market is highly liquid. There is a large number of buyers and sellers, making it easy to buy and sell contracts.
What are the risks of trading futures?
Futures trading is not without risk. Some of the most prominent risks include the use of leverage going wrong, high market volatility, and counterparty risk. Leverage allows traders to control a much larger position than they would otherwise be able to with a small initial investment, and it has the potential to magnify losses should a trader’s market predictions are incorrect.
The futures market can also be volatile, as there are rapid market movements that can be impossible to predict. And finally, traders participate in futures trading on exchanges, and clearinghouses take part in facilitating these exchanges. There is a slim risk that the clearinghouse may fail or default on the trade.
Who trades futures?
Futures trading appeals to a wide range of traders and many traders of different backgrounds participate in trading them. Some of the most common groups of traders include speculators, hedgers, arbitrageurs, businesses, and institutional traders such as banks, hedge funds, and pension funds.
The bottom line
Futures trading takes place on organised exchanges, and buyers and sellers trade standardised contracts on underlying assets across classes. The price of a contract can be determined by supply and demand dynamics. While there are plenty of benefits to trading futures, there are also inherent risks associated with it, and traders should make sure they understand the risk they are about to undertake when they start trading.