The futures market is an exciting and diverse market that allows you to trade futures contracts on everything from corn and wheat to interest rates and stock indices. You are not limited to just one sector of the global economy or to strong economic periods. As a futures trader, you can make money on either market direction.
The basic building block of the futures market is the futures contract.
A futures contract is a contract between a buyer and a seller where the seller agrees to deliver a commodity/underlying instrument to the buyer on a specified date for a specified price.
Futures traders who are in a trade and want to get out of it have to create a new contract to offset the first one.
As a futures trader, you want to know not only how many contracts have been created, but also how many of those contracts remain active. High volume and high open interest are signs of good liquidity in the market, which means it should be quite easy for you to quickly enter and exit your trades at a good price.
Trading Futures Contracts
When you buy or sell a futures contract you do not pay for the full value of the underlying commodity up front, as you would if you were buying a stock. Instead, you post margin, or a performance bond, with your futures broker showing you have enough money to cover any losses you may incur from the trade.
The margin you set aside when you enter a trade is called your initial margin. Once you are in a trade, however, you may not need to maintain the same level of margin, but only to meet what is called your maintenance margin requirement – which, depending on the exchange, is typically lower. Maintenance margin is the amount of money you must set aside to remain in a trade.
Commodity Futures and Financial Futures
We broadly divide available futures contracts into two categories:
Commodity futures are futures contracts based on a physical commodity that you can grow/raise/mine and transport from place to place.
Financial futures are futures contracts that are based on financial products likes bonds and stock indices.
Bid Price and Ask Price
When a futures contract has high trading volume, the spread between the bid and the ask will be quite small. As a futures trader, you want the spread to be as small as possible.
The futures market is the most diverse of the global financial markets. While no other financial market can compare to the diversity of the futures market, others do impact on it. For instance, the U.S. Bond market can affect the value of the U.S. Dollar Index futures contract, just as the Japanese yen can affect the value of the Nikkei 225 Index futures contract.
To become a successful futures trader you will need to recognize the relationships that exist among the world’s financial markets and comprehend how these relationships may affect the futures contracts you are trading.
Buyers and Sellers
While futures contract prices fluctuate from day to day, various futures exchanges limit the distance some of the contracts can move in one trading period. Futures contracts with maximum price fluctuation rules will stop trading if they move too far in any direction.
The contract may:
- stop trading for a few minutes and then begin trading again with a new price limit; or
- stop trading for a few minutes and then begin trading again with the same price limit; or
- stop trading for the day.
Futures contracts also have what are known as limit up and limit down thresholds. If the price of a futures contract moves too high or too low, trading on that contract will stop for a few minutes to allow the exchange directors to determine whether trading should continue that day or if it should be halted to preserve order and prevent panic on the exchange floor.
Specified Date and Price
Every futures contract has a specified date on which it expires and a specified price at which the seller must provide the commodity and the buyer must pay for the commodity.
Futures contracts have three key dates of which you need to be aware:
The notice date is the first day the seller of a futures contract can give the buyer of the contract notice to expect delivery of the underlying commodity.
The expiry date is the day that the futures contract expires. It is also the last trading day for the futures contract.
Every futures contract has a unique ticker symbol that tells you what the underlying commodity is and when the contract expires. Each symbol is comprised of three parts: the instrument identification, the month of expiration, and the year of expiration.
The delivery date is the last date by which the underlying commodity must be delivered from the seller to the buyer. The delivery date is also known as the settlement date. The seller need not wait until the delivery date to deliver the underlying commodity, but can deliver at any time during the delivery period – the period between the first notice date and the delivery date.
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