We all have dreams of our future, but what is a futures contract, and how do we use it to control our destiny? A futures contract is an agreement to buy or sell a commodity or financial instrument at a predetermined price and date, and while it can offer many advantages, there are some risks that should be carefully considered before entering into any such arrangement. In this article, we’ll explore the advantages and disadvantages of utilizing futures as a part of your financial strategy.
1. Pros and Cons of Futures Contracts
Futures contracts have the potential to be incredibly beneficial for businesses, as they are used for hedging, speculation, and arbitrage activities. There are many advantages to using futures contracts, but as with any financial instrument, there are also a few potential drawbacks. Here, we take a look at both the .
The Advantages of Futures Contracts
- The long-term nature of futures contracts allows buyers to lock in a price for their desired commodity, protecting them from potential increases in the underlying market.
- The margin requirement is lower, meaning that buyers can purchase a futures contract for a fraction of the cost of an equivalent physical investment.
- Futures trading is incredibly liquid, as there is an active market of buyers and sellers available to take up positions.
- The ease of trading allows for arbitrage opportunities, which help to maintain market equilibrium and price accuracy.
The Disadvantages of Futures Contracts
- Futures contracts are exposed to a high level of market risk, as prices can be volatile and liable to change quickly.
- The trading of futures is leveraged, meaning that losses can be much more significant than the original investment. This makes them unsuitable for the majority of retail investors.
- As the futures market moves very quickly, it is hard for investors to get in and out of the market without incurring significant losses.
- Futures contracts require the use of margin, meaning that contracts have to be continually monitored and managed to avoid excessive losses.
2. What Are The Benefits Of Trading Futures?
Flexibility and Accessibility
Trading futures offers an immense degree of flexibility in terms of market exposure and trading hours. Futures contracts can be traded across a number of international markets, giving investors increased market access. Also, unlike other stock markets, some futures exchanges are available to trade 24 hours a day, six days a week.
Lower Costs and Increased Leverage
Another benefit of trading futures is the lower costs that are associated with trading versus other types of investments. This includes commissions, as well as other transaction-related fees. Additionally, futures traders often have access to margin accounts, where they can increase potential leverage by investing capital from a bank or other lender. This can allow for portfolio diversification at a fraction of a cost.
- Flexibility and accessibility to international markets
- Ability to trade 24 hours a day, six days a week
- Lower costs and potential for increased leverage
- Ability to entrance and exit quickly and easily
3. What Are The Potential Drawbacks To Futures Trading?
High Financial Risks
Futures trading has the potential to yield a significant return, but it is important to remember that it also has the potential to leave traders exposed to higher losses as well. Compared to stock trading, futures trading involves higher financial risks due to its high leverage system. This leverage feature, which allows investors to control larger positions than they have the cash reserves to cover, is what makes futures potentially lucrative, but it also means the stakes are high. For those without adequate risk management strategies, futures trading can be a very dangerous game.
Miscommunication with Brokers
Another potential drawback to futures trading is the risk of miscommunication and misunderstanding with brokers. Understanding the complex and ever-changing nature of the futures market is difficult for traders with any level of experience — making accurate decisions on their own is impossible. Thus, brokers play an extremely important role in this type of trading and poor broker communication may lead to costly issues. To avoid such issues, it is highly advised to evaluate brokers and regularly reassess their trade execution methods and customer support.
4. Making The Right Choice – Futures Markets Investing
Futures markets investing can seem intimidating and difficult to get started with. You can become overwhelmed quickly when you first start in this arena, but you need to remember that it is not a complicated process. The key to mastering this form of investing is to do your research, and make the right choice.
There are a lot of factors to consider before making a commitment to future investments. You need to factor in the riskiness of the investment which is based on market conditions and the current market trends. You also need to familiarise yourself with the different types of futures available and how they work. A few examples of futures include:
- Commodity Trading: Investing in commodities as a form of future contracts.
- Financial Trading: Investing in a variety of financial instruments such as stocks, bonds, and currencies.
- Options Trading: An investment strategy based on predicting the direction of the price of a particular asset.
It is also important to assess the financial market environment and ensure that you can make a sound decision when investing in futures markets. You need to have an understanding of market sentiment and the risks associated with the specific future you intend to invest in. Research previous historical performance of the particular asset and research technical analysis of the markets and global news that could affect the future markets. With the right information and the right future market, you can reduce the risk and make informed decisions.
The future is a fluid and ever-changing space. While there are advantages and disadvantages of futures trading, understanding these and how they apply to your own unique investment strategy determines whether futures will be suitable for you. With the right knowledge and an eye to the future, we can all chart our own course smarter and more informed. Good luck!