Futures are among the most useful financial instruments in the market. In short, futures allow you to buy and sell financial assets based on their futures.
A good example of futures contracts is what happens in the indices market. Every trading day, you hear media reporters talking about the Dow Jones and S&P 500 before the market opens.
Whenever they do this, they are usually referring to futures that are tied to these indices.
In this report, we will look at the futures market, how it works, and the risks involved.
What are futures contracts
In an old post, we looked at the intrigues in the futures market. We looked at what these contracts were and how to trade them.
For starters, a futures contract is a deal between a buyer and a seller. The two sides meet and agree on a future price of the product.
For example, an airline may want to ensure that it has enough jet oil in the future. To do that, it can agree at a price and quantity with a jet oil supplier.
In this situation, the airline will be protected from the volatility in the oil market while the oil supplier will be protected from price fluctuations.
How the future market works
As mentioned above, the futures market works by having two sides sign a deal about a product. It is also a useful strategy in the financial market where buyers can agree with sellers of a future price.
As such, it applies to the commodities, stocks, and currencies.
Indeed, if you have traded the Dow Jones, DAX index, and other leading indices from an online broker, chances are that you are engaged in the futures market directly.
A futures contract is made up of several things such as:
- how the trade will be executed
- quantity of the asset
- currency in which the contract is denominated
- the grade or quality consideration
The latter point is useful in the physical goods industry.
Risks of trading futures
Futures are essential financial assets in the market today. However, they have their risks.
A good example is what happened in April 2020, when the price of crude oil turned negative. That was the first time it has done that and was because of fears of demand and supply. Therefore, while the price later recovered, most traders who had traded these futures contracts lost money.
Here are two other top risks in futures trading:
Losing more money than you traded
When oil prices went negative, the reality is that many people lost more money than what their accounts had. That is because most people use leverage when day trading futures.
Difficult to predict
While we all have strategies and models, the reality is that no one can easily predict the future. For example, no one predicted the coronavirus pandemic and the impact it would have in the market.
Benefits of day trading futures
While trading futures has its risks, it also has its benefits. In the examples above, the futures transactions enables the two sides to have a peace of mind. Other benefits are:
- More hours – Unlike stocks, futures trading have more hours. As such, you can trade Dow futures when stocks in the Dow are not trading.
- Analysis is the same – Analysis of futures products is the same as the one done in spot prices. You basically use the same technical and fundamental analysis strategies.
- No short sale restrictions – There are no short sale restrictions in the futures market, which means that you can go long or short an asset for as long as you want.
- Margin – Most companies that offer futures do so with leverage, which means that they lend you money to trade.
Futures are among the most innovative products in the financial market. They enable traders to trade in multiple financial assets.
In the real world, they enable companies and goods producers to minimise risk. However, while they have their benefits, they also come with their own inherent risks.
We recommend that you take time learning more about the futures market before you start risking your cash.