What is a futures contract? The most detailed review of how to trade

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futures contract

Although quite similar to a few points with options contracts in the payment method and the subject is investors. But it's a lot of difference. And Blogtienao Find out and give your own evaluation.

What is a futures contract?

Futures contract (future contracts) are a legal agreement to buy or sell a particular asset and secure it at a predetermined price at a specified time in the future. Assets here include goods, securities, stocks, currency,…

It is standardized in quality and quantity to facilitate trading on a futures exchange. Often used to prevent asset price volatility to help prevent losses caused by adverse price changes.

See more: What is Binance Futures? Complete usage guide from AZ

Futures allow an investor to speculate on the price direction of a security, commodity or financial instrument, long or short, and use appropriate leverage.

The investor anticipates that a bull market will open a position to buy futures contracts. When the market rises as expected, investors will get profits. Conversely, an investor can open a short position on the futures contract to profit in the bear market.

How futures contracts work

As I mentioned in the introduction, this is also the product of derivative securities. The predetermined price at which the parties agree to buy and sell assets is called forward price. Assigned future time. It is the time when property is transferred and payment occurs, called the delivery date.

Act as a marketplace between buyers and sellers. In which the two parties have the following obligations:

  • Buyer: Buying and receiving assets when the futures contract expires.
  • Seller: Deliver and deliver property on expiration date.

I give a visual example of the use of a futures contract in a commodity asset namely paddy:

how a futures contract works
how a futures contract works

Futures provide an opportunity for speculation in which a trader predicts that the price of an asset will move in a particular direction. They can sign a contract to buy or sell it in the future at a price (if the prediction is correct) that will be profitable.

Especially, if the speculator has a profitability. Commodities that the speculators trade for have been stored for a long time and sold for as long as they need. Provide consumers with a more favorable distribution of goods.

Content in a contract

Futures, which you can easily trade and trade, are standardized. Each futures contract will typically designate the following components:

  • Commodities
  • How the transaction will be settled: By actual delivery of a certain quantity of goods, or with a cash payment.
  • Quantity of goods to be delivered or insured under the contract.
  • Contract currency has par value.
  • Currencies in futures contracts are quoted.
  • Time of transaction.

Types of futures contracts

I will share the group of assets for everyone to understand:

Group 1: Financial futures contracts

This group includes the following asset classes:

  • Stock index: Affected by how the stock market works. When stocks are under selling pressure, so do stock indices. The opposite is true of buying pressure. Interest rates can also have an effect on stock indices. Higher yields in those products create a money competition in search of safer investments.
  • Currency market: May be affected by interest rates around the world. Capital tends to shift to the money market with the country with the highest interest rates. Geolocation can also have an impact on currency prices. A good government makes investors feel safer investing in that country's currency than a country with chaos.
  • Interest rate: A country with an expanding economy could give their central bank reason to believe inflationary is coming. Then, they started raising interest rates to slow down expansion. If the economy of a country is contracting, its central bank can lower interest rates to try to stimulate their economy with cheaper lending, allowing firms to increase income again again.

Group 2: Physical commodity futures contracts 

The market in this group 2 is more advanced than the first group. There are many factors that can influence these markets to change prices. Factors like weather, politics, geography (tariffs, strikes, etc.), even diseases that affect crops and livestock can all affect prices.

In this group will include the following assets:

  • Energy: For example, crude oil has two byproducts, gasoline and hot oil. Depending on the time, crude oil demand is determined by several factors. However, other factors such as refinery fires, shutdowns, etc. can also disrupt supply distribution and cause price reactions.
  • Metal market: Varied, here you will find gold, silver, copper and platinum. Central banks around the world keep gold in their warehouses to fight any potential inflation.
  • Agricultural products: may include grain and livestock. Both are hit hard by seasonal patterns that can drive prices up or down.
  • Soft goods: Includes goods such as sugar, cocoa, coffee, cotton and wood. Most are low volume and usually not traded by smaller traders. However, they are commodity products that we use every day in our lives and that means that the basic factors of supply and demand still affect the prices of these products.

How to trade futures contracts

It is relatively easy to start futures trading. Open an account with a broker that supports the markets you want to trade. A prospective broker will probably ask about your experience with investment, income and net worth. These questions are designed to determine the level of risk the broker will allow you to take, in terms of margin and positions.

There is no industry standard for the distribution of commissions and fees in futures trading. Each broker offers different services. Some offer lots of research and advice. While others simply provide you with quotes and charts.

Some websites will allow you to open a trading account. You can practice paper money trading before you actually commit to your first transaction. This is a way to test your understanding of the futures market and how it works, as well as the leverage and commissions with your portfolio.

If you are a beginner, I recommend spending some time trading in a virtual account until you are sure you understand it.

Even experienced traders will often use virtual trading accounts to test a new strategy.

Evaluate the pros and cons of futures trading

Advantages

  • An investor can use futures contracts to speculate in the direction of the price of an underlying asset. My assets are listed in the section of the contract.
  • Firms can hedge the prices of the raw materials or products they sell to protect against adverse price movements
  • Futures contracts may only require a partial deposit of the contract amount with the broker.

Disadvantages

  • Investors are at risk that they may lose more than their initial deposit due to leveraged futures.
  • Investing in a futures contract can cause a company to miss out on favorable price movements.
  • Margin can be a double-edged sword meaning high profits come with big losses. In this part, we will analyze the next section

Risk of margin trading and leverage

Many speculators borrow a substantial amount of money to play the futures market. That is the main way to exaggerate small price movements to be potentially profitable. But borrowing also increases the risk. If the market goes against you you could lose more than you invested.

Lever and the margin rule is much more liberal in futures trading. The greater the leverage, the greater the profit, but the potential loss is also greater.

Read more about margin trading: Binance Margin Trading: A comprehensive guide from AZ for newbies

Futures, beyond commodities

Commodities represent a large part of the futuristic trading world. You can also trade futures of individual stocks, stocks of funds, bonds or even Bitcoin. Some traders prefer futures trading because they can take a significant position (amount invested). That gives them greater leverage potential.

Most investors think about buying an asset. It is then predicted that its price will increase in the future. But short selling always makes investors do the opposite. They borrow money to bet that the price of an asset will fall so they can buy later at a lower price.

Summary 

There are always "High profits with great risks" in any form of transaction. So Blogtienao introduced to you the article about "Futures contract ”.

Thereby going into details from the meaning to the transaction to create profits as well as help you to reduce risks. By trying before deciding to join a new trading method, it will help you to preserve your assets. Further is to increase knowledge to go further in the market.

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