To invest successfully in futures contracts, you need to assess where the market is headed as accurately as possible.
One resource is professional analysis, which may be either fundamental or technical. Most futures traders rely on both perspectives in making their decisions.
What are Futures?
Futures contracts are exchange-traded obligations. The buyer or seller is contingently responsible for the contract’s full value. The buyer goes long (establishes a long position) and is obligated to take delivery of the commodity on the specified date.
A seller goes short (establishes a short position) and is obligated to deliver the commodity on the specified future date. If the seller does not own the commodity, his potential loss is unlimited because he has promised delivery and must pay any price to acquire the commodity to deliver.
As prices change, gains or losses are computed daily for all open futures positions on the basis of each day’s settlement price. Gains are credited, and losses are debited for each open position, long or short. All accounts for firms and traders must be settled before the opening of trading on the next trading day. Physical commodities and financial instruments are examples of underlying assets. Futures contracts are standardized to make trading on a futures market easier and specify the quantity of the underlying asset. Futures can be used for trading speculation or hedging.
How to choose futures to invest in?
Most futures traders rely on fundamental and technical analysis in making their decisions. They use fundamental research to examine market conditions and technical research to support or question their price predictions.
You can access analysts’ research information through your brokerage firm, the exchanges, and investment professionals. You can also find futures trading information, including real-time or slightly delayed contract prices, on the exchange website that lists the contract you’re considering, on the websites of brokerage firms that execute futures transactions, and in various print and online material. And you can check financial websites for reports on daily trading activity.
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What is fundamental analysis?
Fundamental analysts try to determine the supply of a particular commodity and the corresponding demand. Changes in contract prices, which drive profit or loss, are based mainly on whether there is a surplus, which drives prices down, or a shortage, which drives prices up.
With agricultural commodities, the analyst looks at weather forecasts, projected crop yields, the likelihood of crop failures due to disease, financial factors affecting farmers’ activities, and the prices of alternative, competing commodities. For example, the lumber market is driven by housing starts. Copper mining futures are affected by labor and political unrest in countries with significant mining output.
The concerns are different with financial commodities. For example, demand for a particular currency is affected in part by US consumers buying products priced in that currency. So analysts may look at the volume of Japanese electronics or automobiles that US consumers buy. The more these products are in demand, the higher the value of the Japanese yen tends to be against the dollar.
What is technical analysis?
Technical analysts ignore supply and demand, looking instead at the futures market itself — including price behavior, trading volume, and open interest, which is the number of outstanding contracts on the commodity that have not been offset.
For example, technical analysts chart prices to detect the pattern in which they’ve been moving, to determine a trend line, and to assess when the direction is going to change. Using sophisticated computer programs, they digest and analyze data on the complex relationship linking trading volume and price trends.
What futures to choose for investing?
You should decide which futures market is best for you out of the different options available. They include:
– Interest Rates
– Stock Index
Stocks, bonds, and currencies are the commodities of the financial world. Like other commodities, financial futures contracts trade on specific exchanges, where they are often among the most actively traded products.
A commodities futures contract is a contract to buy or sell a specific commodity at a later time. Commodities are the raw materials. They are consumed in the process of creating food, fuel, clothes, cars, houses, and many other products that we buy — the wheat in bread, the silver in earrings, the oil in gasoline. They allow hedging against price changes in the future of various commodities.
Currency futures are one of the numerous types of financial futures. This futures contract enables you to purchase or sell a currency at a predetermined rate in relation to another currency (such as the euro against the dollar, for example) at a future date.
Focusing on markets related to the businesses, industries, or sectors you are already familiar with is an excellent approach to getting started with the futures. For instance, gold futures may be a fantastic choice for your first transaction if you’ve long invested in the stocks of precious metal mining companies. In addition, you’ll have more time and attention to follow the discussion and news for only one or two markets if you narrow your focus to just those.
What are Managed Futures?
Rather than trading futures through an individual trading account, you may participate in the futures market through a managed account or a commodity pool.
A managed account is your own individual futures trading account, except that you have given a registered professional account manager, sometimes called a commodity trading adviser (CTA), a written power of attorney to make all the trading decisions. You may need to commit more money to open a managed account than to trade yourself. And you’ll pay management fees in addition to the usual transaction fees.
Commodity pools combine your money with money from other pool participants to create an account similar to a stock mutual fund, but not a mutual fund. Because a commodity pool is usually structured as a limited partnership, you share in the gains and losses in proportion to your investment. Still, your risk is limited to the amount of your investment. That means you are protected from the margin calls in this highly volatile market.
Another potential advantage of a commodity pool is the diversification it adds to your portfolio by:
- Investing in a variety of futures contracts
- Providing a return with a low correlation to the returns on most traditional investments.
You should review the disclosure documents that the commodity pool operator gives you to determine the fees involved and the trading philosophy and practice. For newly formed pools, you need to find out whether active trading has begun or is contingent upon raising a minimum amount of pool money. In the latter case, you’ll want to know what is being done with your money in the interim until the pool begins trading.
Both CTAs and commodity pool operators must be registered with the CFTC and be members of the NFA. You can check the credentials of firms and individuals in the futures industry by using NFA’s Background Affiliation Status Information Center (BASIC) on the NFA website.
What to consider before investing in futures?
Futures are complex and volatile, so they can make the investor vulnerable to massive losses, even for small movements in the market. Therefore, before trading futures, investors should plan and conduct their research and be aware of both the benefits and risks.
Consider a few things even if you trade through a broker. First, choose which of the numerous futures markets suits your particular trading style. For example, some indices have greater volatility than others, making them more suitable for day traders who trade for only a few days. Setting up stop-loss or take-profit levels is one of the often utilized techniques for seasoned traders to manage their trades. A take-profit is the highest profit you’ll allow, whereas a stop-loss is a maximum loss you’re willing to take.
A Demat account is not necessary for derivative trading. However, in terms of cost, it is frequently considered to be a more cost-effective option. But don’t let the lower brokerage mislead you. Some additional expenses include stamp duty, statutory fees, goods and services tax (GST), and securities transaction tax. Before you trade futures — individually, through a managed account, or as part of a commodity pool—you can learn more about the risks and potential returns by reviewing a booklet called “Opportunity and Risk: An Educational Guide to Trading Futures.” It’s published by the National Futures Association (NFA).
The pros and cons of the futures
You should know the main advantages and disadvantages before you begin, just like with any other trading approach or strategy. Futures belong to the group of financial products known as derivatives because their prices reflect, or are derived from, the value of the commodity underlying the futures contract.
Futures contracts are highly leveraged instruments. Under most circumstances, you can buy or sell a futures contract with a good faith deposit called an initial margin, which is a percentage of the underlying item’s value, often 10% but 20% for a security future.
Similar or even identical contracts may trade on more than one exchange, but one contract on a particular commodity dominates the competition in trading volume and liquidity. In other cases, an exchange may have the exclusive right to list contracts on a specific commodity. Futures contracts expire on a specific day each month and are dropped from trading. For example, US Index contracts expire on the third Saturday of the expiration month and can be liquidated or offset on or before the third Friday.
Even though everyone can trade futures, numerous difficulties might make the process challenging. If you want this strategy to be effective, you will need to put in a lot of time and work. This entails keeping an eye on the market and staying informed about current affairs.
How To Invest In Futures? by Inna Rosputnia
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