Futures trading is the investment style of buying or selling futures contracts. Futures contracts have been used to manage cash market price risk for more than one century in the world. Unlike a stock, which represents equity in a company and can be held for a long time, if not indefinitely, futures contracts have specific time period. Futures trading allows a market participant to lock in prices and margins in advance and reduces the potential for unanticipated loss.
Futures contracts trade in standardized units in a highly visible, extremely competitive, continuous open auction. In this way, futures lend themselves to widely diverse participation and efficient price discovery, giving an accurate picture of the market.
There are two basic categories of futures participants: hedgers and speculators. In general, hedgers use futures for protection against adverse future price movements in the underlying cash commodity. The rationale of hedging is based upon the demonstrated tendency of cash prices and futures values to move in tandem. Speculators are the second major group of futures players. These participants include independent floor traders and investors. Independent floor traders, also called “locals”, trade for their own accounts. Floor brokers handle trades for their personal clients or brokerage firms.
For speculators, futures trading has important advantages over other investments:
Futures are highly leveraged investments–The trader puts up a small fraction of the value of the underlying contract (usually 5%-15% and sometimes less) as margin;
Commission charges on futures trades are small compared to other investments–the investor pays them after the position is liquidated;
Most commodity markets are very broad and liquid–Transactions can be completed quickly, lowering the risk of the time delay from the decision to the execution.