All you need to know about Futures Trading

What is a Futures contract?

A Futures contract is a legally binding agreement made between two parties to buy or sell a commodity or financial instrument, at an agreed price, on a specified date in the future. The quality and quantity of each contract is standardised. Hence, the price at which the contract is established is the only variable and is determined between the buyer and seller at the time when the contract is traded. Futures contracts are listed on Exchanges and the performance and obligations under the contract are guaranteed by the Exchange's Clearing House.

Why trade Futures?

Futures have the following great advantages that make them appealing for all kinds of investors - speculative or not. However, highly-leveraged positions and large contract sizes make the investor vulnerable to huge losses, even for small movements in the market. Thus, one should embrace prudent risk management before trading futures.

  • 1. Futures are Highly Leveraged Investments

    An investor has to deposit a margin - a fraction of the nominal value of the contract to be invested in futures. The margin is a security that the investor has to keep with the exchange as obligation to the Futures position he holds. Futures positions are marked-to-market to the daily price and all positions are required to be maintained at the minimal requirement set by the Exchange. The leveraged effect also means the profit or losses can be hugely exacerbated and clients may face losses higher than the amount of Margin deposited.

  • 2. Futures are Great for Diversification or Hedging

    Futures Contract is useful for hedging or managing different kinds of risk. The costs of trading Futures is much lower than its underlying and provides a perfect insurance against any adverse price movements that may affect the investments on the underlying. Most of the time Futures prices react faster than its underlying and provides the direction ahead of its underlying price.

  • 3. Futures Contracts are Basically Only Paper Investments

    The actual stock/commodity being traded is rarely exchanged or delivered, except on the occasion when someone trades to hedge against a price rise and takes delivery of the commodity/stock on expiration. Futures are usually a paper transaction for investors interested solely on speculative profit.

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