5 Facts to Understand About How Futures Trading Works
Before we look into facts revolving around future markets, it is good to start by defining the term. This is an auction market whereby the participants are accorded the opportunity to purchase and sell futures contracts and commodities to be delivered on a specific date. Initially, the trading would be conducted through hand signals when people are gathered in a trading pit. The futures exchanges are currently electric.
Below are five facts about futures trading:
- Use Stop Orders
While engaging in trading, the main aim is to make a profit. Do you want to know how to win a trade? Well, you should be disciplined. A trader must know when to get in and out of a trade. Ensure you have a game plan.
Come up with a plan and determine the amount of money you are willing to stake and the profits you expect to make. Stop orders ensure that emotions are not part of the trade.
A stop order ensures that you will buy and sell at a specified price. The order ensures the losses are limited and the gains are locked. The amount you trade should enable you to make more money compared to what you may lose. Most professional traders will advise you to have a risk-reward ratio.
- Who Trades in Futures?
The people who trade in futures are speculators and hedgers. The hedgers usually use the futures to protect themselves from price movements in the future. Speculators comprise investors and traders.
The advantages of investing in futures include:
- Liquidity- the investment guarantees liquidity considering factors such as supply and demand. The trades can be performed in real-time, and investors can ensure there is minimal spillage.
- Leverage effect- the traders, need to commit a small amount of money to control a considerable amount of the product.
- Diversification- if you want a diversified portfolio, you should invest in the futures. The overall risk will be reduced, and the total profits will increase.
- Daily movements- futures are suitable for short and long-term trading. The movement creates a chance to make significant profits.
- Consider What You Can Do with Futures
In the finance sector, futures trading serves the following functions:
- Leverage- as an investor, you can create leveraged positions using futures. Leverage allows you to control a contract with an immense value using a considerably small amount of capital. Leverage showcases the trader won’t need the whole contract amount value to enter into a trade. The broker is supposed to have an initial margin amount, which is a percentage of the full contract value.
- Risk Management and Hedging- futures trading helps to mitigate certain risks. For instance, as a farmer, you will gain from futures trading.
- Automated Trading Systems and Futures
Futures can be used when dealing with an automated trading system. Good trading ideas normally start with an instrument, and specific characteristics determine whether a particular trading system is a good fit.
- Exit Strategies for Futures Trading
After a particular position in the future contract is taken, you can try out the following actions:
- Rollover- The expiration date can be extended by the trader when dealing with an expiring future. In this case, the position on the contract can be taken on the future contract with the expiration date that will be set later.
- Offsetting- when an opposite transaction is created, the position present on the futures contract is closed.
Futures contracts are significantly utilized in the finance sector, and different functionalities make them a suitable option for different use cases. It is good to better understand different mechanisms relating to futures contracts and their markets before making any speculations.