The futures market is an important component of the broader financial market complex. It is also one of the most advanced in the industry.
In this article, we will explain briefly what the futures market is and then identify some of the most important futures assets that you can trade.
What is the futures market?
The futures market is based on a simple concept. The idea is that a buyer and seller of a certain asset will come into an agreement on a future transaction. The buyer will agree to buy a certain asset at a later date at a certain price.
Futures were mostly used in the agricultural industry where suppliers and buyers entered into long futures contracts. The buyer will promise to buy a certain amount of an item at a certain amount. As a result, it provides a situation of a mutual benefit to the participants.
The seller benefits by having a ready market for their products and the buyer benefits by having a good price for the products.
However, it is also risky to both sides.
For the seller, the risk is that the price at the agreed date will be higher than where it is today. For example, if the price of crude oil is trading at $80 and the two can agree to do the transaction at $85 in two months. Now, if the price will be at $100 in that period, the seller will be at a loss.
For the buyer, the risk is the opposite. The price at which the purchase is set is higher than what it will be in the future.
Let's take the same example of crude oil. If the two parties agree to make the transaction at $85, but the price at that time will be $75, the buyer will have made a loss.
Who uses the futures market?
While the futures market is an ancient one, the reality is that it is used widely today. Many industries rely on it to manage their supply chains.
For example, airlines enter long futures contracts with their fuel suppliers. That is why, in many cases, advanced airlines don’t suffer from oil price shocks when prices move up and down. These contracts help to cushion them from the shocks.
Another industry that uses the futures market is agriculture. A good example of this is in the cocoa business. Ideally, companies like Nestle and Hershey are the biggest buyers of cocoa, which they use to manufacture chocolate bars.
These companies buy most of their chocolates in Ivory Coast and Ghana. But they don’t buy their inputs in the spot market. Instead, they enter long-term contracts with producers where they pledge to buy a certain amount of cocoa at a certain price.
Some of the biggest users of the futures market are known as ABCD, which are the biggest companies in the grain industry. These companies, Archer-Daniels Midlands, Bunge, Cargill, and Dreyfus. These firms use the market to manage their supply chains in the agricultural industry. So, let us look at some of the top assets you can trade in the futures market.
» Related: Supply Chain Analysis for Stocks Investing
Futures Assets to trade in the market
While the futures market originated in the commodities industry, it is now widely used in the stock market. And while participants had to make agreements in the past, the process is now fully automated, meaning that anyone can participate.
Stock futures are mostly provided to brokers from large companies like CME and CBOE Markets. The process of trading futures is similar to trading spot prices in that traders look at the fundamental and technical analysis.
In fundamental analysis, you will find the key potential movers for a stock such as earnings, management change, and a new product launch. Technical analysis, on the other hand, will give you more details on price action by looking at key indicators like moving averages and the average directional movement index.
One benefit of trading stock futures is that they are usually highly liquid and that they have a long trading period in a given day.
Cryptocurrencies are a relatively new asset class in the markets today. Therefore, their use in the futures market is a bit limited today considering that only Bitcoin and Ethereum are offered by the mainstream companies like CME and CBOE.
Nonetheless, some companies in the industry have taken steps to introduce futures for the industry. Most of these futures are perpetual futures contracts. They are cash settled but don’t have an expiry date
Cryptocurrency futures are getting more popular such that the first Bitcoin ETF was launched using the futures data instead of spot prices.
Currencies, popularly known as forex, are an important market because of the volume of trading that happens every day. Estimates place the daily trading volume figure at more than $5 trillion, making it the most liquid market.
It is possible to trade forex futures. You first need to find a broker that offers forex futures that are mostly created by companies like CME. Then, you will do your analysis as usual and then place the trades.
The other asset that you can trade well in the futures market is commodities. There are several types of commodities that you can trade. There are agricultural commodities like corn and soybeans. Further, there are precious metals like gold and silver and industrial metals like copper and bronze. Other commodities that you can trade are lumber, crude oil, and natural gas.
Indices are some of the most common assets in the futures market. For example, every weekday, you will hear media professionals predict the price that indices like the Dow Jones and S&P 500 will open at. They do that by using data from the futures market.
In this article, we have looked at what the futures market,, even if in a summary way, and then we moved on to analyze who are the real players that come into play in this particular market.
We then analyzed the most important assets that a trader (or an investor) may decide to trade in the futures market. Feel free to propose others that you think deserve mention!
External useful resources
- Commodity Futures and How They Work, With Examples - The Balance