definition – futures:
Future is a standardised contract to buy or sell something at a predetermined price and time in future. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. And, the specified time in the future, when delivery and payment occur, is known as the delivery date. Since it is a function of an underlying asset, a futures contract is a derivative product.
Futures exchanges, act as a marketplace between buyers and sellers. The buyer of a contract is said to be the long position holder. And the selling party is said to be the short position holder. Both parties risk their counter-party walking away if the price goes against them. Therefore, the contract may involve both parties maintaining a margin. The margin may equal the value of the contract or Daily P&L with a mutually trusted third party.
Futures contracts have standardised lots and expiry to facilitate trading on a futures exchange and therefore benefit from high liquidity. However, this comes at the price of not being able to create a bespoke product for the buyer. There are OTC(Over The Counter) Forward contracts that allow this. However, we will focus on the Futures contract for the purpose of this article.
history of futures contract
The Dutch pioneered several financial instruments and helped lay the foundations of the modern financial system. In Europe, formal futures markets appeared in the Dutch Republic during the 17th century. The Dōjima Rice Exchange was established in 1697 in Osaka, Japan. And it’s considered by some to be the first futures exchange market. It was created to meet the needs of samurai who, being paid in rice, and after a series of bad harvests, needed a stable conversion to coin.
The Chicago Board of Trade (CBOT) listed the first-ever standardized ‘exchange traded’ forward contracts in 1864. These were called futures contracts. This contract was based on grain trading. And started a trend that saw contracts created on a number of different commodities. In addition, a number of futures exchanges set up in countries around the world. By 1875, cotton futures were being traded in Bombay in India. Followed by futures on edible oilseeds complex, raw jute and jute goods and bullion.
So, the early futures contracts were negotiated for agricultural commodities, and later futures contracts for natural resources such as oil. However, the original use of futures contracts was to mitigate the risk of price or exchange rate movements. This was done by allowing parties to fix prices or rates in advance for future transactions.
modern day futures market
Futures contracts also offer opportunities for speculation. For instance, a trader can predict that the price of an asset will move in a particular direction. He can then, contract to buy or sell it in the future at a price which will yield a profit. If the prediction is correct.
Institutional traders usually roll their positions prior to expiration to maintain their exposure to the market. They might do this because they may have offsetting OTC forward contracts that they have created for their customers. Or they simply have a longer term view and do not intend to take physical delivery of the commodity. There are also opportunities to profit from pricing anomalies during these rollover periods.
Futures are commonly traded for below financial asset classes
- Forex (FX) market
- Money Market (for example, interest rate futures)
- Bond Markets (also interest rate futures)
- Equity Market (single stock and composite index futures)
- Commodities Market (Gold, Crude Oil, Corn etc.)
- Others – Energy, Carbon, Emissions, Bitcoin etc.
Most futures contracts are coded with five characters. The first two characters identify the contract type. The third character identifies the month. And, the last two characters identify the year.
basics of trading
zero sum game
Many people begin trading futures without fully understanding the fundamentals of the contract. For each trade there is a winner and a loser. And when trading futures, you are playing in markets dominated by big players. Many companies and professional fund managers use futures to hedge their other positions. They are using the futures contract to reduce the risk of their portfolio. For instance, gold produced by a mining company who wants to fix in a specific sale price. While future contracts protect against the downside of price fluctuations, they also limit potential upsides as well.
Long-term success in futures trading comes from mastering three disciplines. If you are a successful stock or fx trader, you are probably familiar with these rules. Firstly, you need a proven trading process that works for futures trading. Secondly, sound money management techniques can go a long way to helping you win the futures trading game. Finally, any time your emotions control your trading, you are likely to lose.
As an individual in the Futures trading exchange, you are up against the biggest and the best in the world. So, it is important to get access to tools that experienced traders use. Otherwise, you are playing with a handicap. Professional traders have models to calculate the fair value of an asset. And to decide whether to play short term or long term market correction game. For instance, STOKAI is one such tool. You can read more in the FAQs on how to use it.
Go through books and papers on futures trading written by well known authors. Generally, thrill seekers tend to dive in straight into the markets. There is no skipping through. Each successful trader has had their elbows in the mud.
capital and money management
Do you have a lot of capital for futures trading as well as expenditure on infrastructure and operation? In general, we would not recommend trading futures for an account with less than $25,000 capital. Let’s say the dividing line between a high- versus low-capital account is $100,000. Capital availability affects many choices. The first is whether you should open a retail brokerage account or a proprietary trading account.
With a low-capital account, we need to find strategies that can utilize the maximum leverage available. Of course, getting a higher leverage is beneficial only if you have a consistently profitable strategy. With a low capital, you will always be chasing high risk trades to make a reasonable profit. So, this is not a good position to be in.
An experienced trader has strong risk management practices and emotional stability. Hence, doesn’t need the guidance given by a proprietary firm. But, less experienced traders may benefit from the imposed restraints.
Finally, the soft skill needed in trading. Fear, anxiety, and greed are common traits in everyone. Keeping them under control is an ongoing effort. When they take over, your trading results will suffer. Instead of fear, some of you are planning to trade because of the love of thrill and danger. Or an incredible self-confidence that instant wealth is imminent. This is also a dangerous emotion to bring to futures trading. Also, the reason, almost 70%-80% of retail traders lose money. Instant wealth is not the objective of trading. Therefore, the ideal trader is someone whose emotions have found the right balance between fear and greed.
It is important to spend some time learning the history and basics. This time spent will yield dividends when you are trying to predict movement of an asset. Also remember that you are more rational before you place a trade. So, it’s important to set some rules. If you like market conditions and they fit what your rules suggest, go for it. If the conditions for the rules don’t fit what you see in the markets, don’t trade for it’s own sake. You don’t have to trade every day. The point of having rules is to run them to your favour, and not let them run you.
Day trading follows the same rules we use for life. Successful trading is the art of using knowledge and skills at the right time. It is also essential to set some limits once you open a position. For example, you may impose a limit on yourself to not keep a trade open for more than 20 days. Finally get access to good tools that can help you achieve your trading goals. It’s best to try out a lot of things on paper money accounts before risking your capital.
Despite of all the rules, limits and right mindset, random events will happen. So always have a contingency plan. A perfect system or rules don’t exist. And, this is a good thing. Otherwise, someone will work it out and own half of the free world. All algorithms, tools, systems and rules are based on a snapshot of data. So always pay attention to news and data on a given day.
how to apply this to trading
STOKAI provides daily prediction using algorithms based on all factors that impact commonly traded Futures. Then, it evolves the forecast over 10 days in the future. Tutorial and brief user guide is available here – Tutorial. If there are any issues, please contact our customer services team.
Stokai is a product of Rumble Horse Tech ltd. A company registered in England.