Strategy for Futures Trading

Futures trading can be a very profitable exercise, because of the leverage that futures contracts exhibit. With a good futures trading education, it is one of the types of trading that has the most potential for an excellent profit. However, the concept of leverage works both ways, so if your futures trading strategy is flawed, you may find that you run out of money very quickly.

*A futures contract is a standardized contract, to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market determined price (the futures price).

*according to Wikipedia

Definition:

Futures are nothing more or less than a contract that is promised to be fulfilled in the future. This contract is binding, unlike options, and must be satisfied. Depending on the commodity traded, you usually do not need to supply or receive it in physical form, which may be a relief if you are dealing in livestock, or large quantities of grain. The contract is normally settled financially, with a payment either way depending on the market price of the commodity on the settlement date.

Cost:

A futures contract might typically cost 5% of the underlying commodity price, and an interesting feature is that the daily price is reflected in your account at the broker. If the value of the futures contract increases, then you have more money in your account immediately that you can use for other trading. On the other hand, if the value drops then you may find the broker asking you to provide more funds, even though you have not placed any more trades.

Broker Policy:

Before you start trading futures, you will want to be sure of your broker's policy regarding such “margin calls”-- whether they will accept a mailed check or need a wire transfer, and what level of funding will trigger this request. In order to keep problems to a minimum, you may want to take a futures trading course, so that you are sure that you fully understand the commitments you are making when you trade futures.

Choosing Futures to Trade:

If you choose to trade futures in crops and other farming products, then the weather will play a part in your trading decisions. On the one side of the contract you may have the “hedger”, for example a cereal manufacturer, who wants to know a guaranteed price in advance for the grain; and on the other side is often a “speculator”, who has no real interest in the commodity apart from being a vehicle for possible financial gain.

Risk Management:

One method of futures risk management is to trade “spreads”. In its simplest form, a spread involves buying one futures contract and selling another for the same commodity with a different contract date. The profit for this trade comes from any difference in the relationship between the buying and selling prices over time.

Conclusion:

If the market as a whole rises or falls dramatically, then you are protected from the excesses by your combined position. So if the harvest was devastated by the weather, you would be protected from taking the full loss. Your gamble on this trade is that the relative prices will change to benefit your position, and you would take your profit by liquidating both contracts at the same time.

Futures Trading Strategy