| No Guts, No Glory |
| Written by Aaron Adam | |
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Another key attraction to the futures markets are their ability to allow someone with limited capital resources to earn a lot of money in a relatively short amount of time. The market is also fraught with risk, and many who have bet their nest egg on it have ended up severely disappointed.In the late 1970s only about 14 million futures contracts were traded per year. In 2009, more than a billion futures contracts changed hands worldwide. These numbers are a testament to the growing popularity of the futures market. There are a vast number of commodities that are traded on the futures market. Some of the more popular futures traded include oil, currency, metals and farm products. While futures trading may appear rather arcane to the weekend warrior investor, the market can be understood once you grasp some basic fundamental concepts. Futures trading is basically a clearing house and auction market for real time information about the supply and demand of various commodities. Commodities are goods which are in demand, but which is supplied without qualitative differentiation throughout a market. This means that no matter who produces it, the product is the same. Some examples of fungible products that would fit this definition are oil, wheat or lead. The price of lead is the same no matter who produces it, and the price fluctuates up and down daily based on worldwide supply and demand. Plasma televisions, on the other hand, are qualitatively different in that their price and perceived quality varies according to the producer (A Sanyo television may sell for a different price than an RCA.) The purpose of trading futures is to provide a means for managing price risks in the commodities being traded. When a trader buys a futures contract, he is helping the overall market to set a price level for items that will be delivered at a date in the future. This helps various other interests insure against changes in price that would be detrimental to their bottom line. The futures market is beneficial to consumers and producers overall because it helps establish timely information about supply and demand and reduces the costs of production, marketing and processing. There are generally two groups of futures traders. Traders who seek to make profits by predicting how the market will move, upward or downward, and then purchasing a contract on a commodity in line with this prediction. The trader does not intend to make use of the commodity, nor will he make or take delivery. The purpose of futures trading is simple, it provides an effective and efficient means of managing price risks in commodities. When you purchase a futures contract, what you're essentially doing is setting a price level now for items that will be delivered at a later date. This effectively provides individuals and companies insurance against adverse fluctuations of price, a practice known as hedging. Hedgers are traders whose business may have an interest in the commodity and are looking for a way to buy or sell it at a price that's favorable to them. For example, an airline company seeing rising fuel prices may enter into a contract to buy fuel for the current going rate three months from now, expecting that by then the going rate will actually be much higher. When you buy a futures contract, you're making an agreement to either buy or sell a determined amount of a specific commodity at a pre-determined price in the future. In a lot of futures contracts, the underlying deal is based on the expectation that the terms of the contract will be satisfied by the actual delivery of the commodity. Many futures contracts instead ask for a cash settlement instead of delivery and these contracts are usually liquidated before the the contracts' due date. There are also a number of refinements that can be purchased in futures contracts. Investors can further limit their risk -- for a price -- by buying options on futures contracts. When you buy an option on a futures contract, you purchase the right, but not the obligation, to buy or sell a futures contract during a certain window of time. Because you're not obligated to the contract, your risk is less, but so is your potential for profit because of the cost of the option. Futures markets are a great investing opportunity for experienced investors, but novice investors should seek experienced financial advice or take steps to thoroughly educate themselves in the field before venturing into futures trading because of the high level of risk involved. |
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