Understanding Hows Trading Futures Works

Trading Futures is based upon trading Futures Contracts. What exactly is a Futures Contract? A Futures Contract or what is often referred to as a "Forward" Contract, or even a cash forward sale, is a contract between a buyer who wants to buy a commodity and a seller who wants to supply a commodity for delivery at a given future date for the current Market price. Futures Contracts are formal agreements obligating the buyer and the seller. When trading Futures, no money changes hands until the date of delivery. Trading Futures is known as zero sum because for every dollar made by the buyer, the seller loses a dollar and vice versa. For example, If corn prices fall, the farmer suffers, but the bread manufacturer benefits. If corn prices rise, the farmer benefits but the bread manufacturer suffers.

Trading Futures happens on the floor of the exchange, like the Chicago Mercantile Exchange (CME), where trading happens in an open outcry pit. Trading Futures is also done "electronically," where traders have internet connections and desktop trading platforms, submitting their buy and sell orders.

Futures traders are divided into two groups, speculators and hedgers.

Hedgers can be farmers, exporters, importers, or manufacturers. Hedgers sell futures positions to reduce their risk, fearing that the price of their commodity falls. For example, a corn farmer knows his crop is to be harvested in October. He sells corn futures prior to the harvest at the current price in July for delivery in October. In July, the price of corn is high. Should the price of corn fall in October because of a bumper crop, the farmer's price is already protected. The farmer, of coarse, is taking a risk. There may be no bumper crop in October and the price of corn rises even further.

Speculators trade Futures to earn a profit. Speculators actually comprise the majority of traders in most markets. Speculators will take on risk, hopefully, selling high and later buying back low (going short) or buying low and selling high (going long). Speculators provide liquidity nneded to make the Futures market work, for without speculators, no one would be there to take the other side of the hedgers' contract. Just like the example above, the farmer sells the corn to the speculator in July for the current price; the speculator assumes the risk, hoping that by October (the delivery date), the price of corn has gone up and he can make a killing at the farmer's expense. One thing he doesn't want to happen: in October, the price of corn goes down and he has over paid.

Before the CME and other organized Futures exchanges, trading Futures was even more risky. Contracts for individuals, between one farmer and one speculator, were signed in the location that the farmer happened to be selling his produce, such as farmers markets. Unfortunately, there were major problems with individual Futures contracts. For example, either the speculator, who was losing money, could default on the contract, or the farmer could default because he could not deliver. Who oversaw payments? Individual contracts were tailored between specific individuals. Therefore, the speculator could not sell his contract to another potential speculator because the contract was drawn up for him, alone. Without a centralized exchange, who would certify the quality of the delivery? Farmers could fill their end of the contract with lower grade product.

With the coming of organized exchanges, the responsibility to certify delivery and payment was left to the exchange. Now exchanges could require payment upfront and be deposited with a third party, ensuring contract performance, reducing contract defaults. Exchanges created standardized contracts, stipulating contract terms, such as commodity delivery dates and commodity grade.

Since then, trading Futures has evolved beyond buying and selling commodities. Today, investors are trading futures across many different asset classes, including energies, currencies and equities. Futures are considered to be "derivatives." What is a "derivative?" A security whose price is "derived from" at least one underlying asset. For example, the S&P 500 Futures Contract, traded by professionals, has the S&P 500 Index traded on the NYSE as its underlying asset. The S&P 500 Index is, probably one of the most monitored stock indexs in the world. The index represents a combination of the top 500 stocks traded on the New York Stock Exchange (NYSE). The stocks that comprise the S&P 500 are the most well recognized companies. Here's the problem...you cannot trade an Index. The CME created an S&P 500 Futures Contract that you can trade. With trading S&P 500 Futures, when the value of the S&P 500 Index appreciates, the S&P 500 Futures Contract appreciates as well and vice versa.

Futures are also based upon currencies. For individual traders, the Currency Futures Market is designed so that individual investors can trade a small number of contracts. This way, individual investors can trade the exact same currencies traded in the Forex market, but trade on the CME. Read Currency Trading for more information.

Shadowtraders specialty is training individual investors in the art of trading Futures. Surf the internet, you will see other Futures education companies, but they concentrate solely on the S&P 500 Futures Contract, and in particular the Emini version of that tailor made for individual traders. Shadowtraders, conversely, is more excited to introduce its customers to a wide variety of Futures contracts, currencies, equities, treasuries, etc. Shadowtraders trades contracts that have liquidity and volatility, with both technial analysis and fundamentals,whether you can or can't trade that instrument, knowing the days of the week that an instrument trades, the times of day, etc. That is our specialty.

If you are bored by only trading the S&P 500 Emini and want to expand your trading, or you are a beginner with trading Futures, attend a Shadowtraders Webinaron Monday nights.

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