Why Trade Futures and Commodities?
Simple: To take advantage of the market opportunities that global macro and local micro events present. Issues in the middle east? Trade oil futures! Economy is volatile? Trade gold futures! Drought in the Midwest? Trade corn and wheat futures. Brexit rocks the UK? Trade the British pound currency futures.
Whatever is going on with the world economy, you can take advantage of a futures market that is correlated with that part of the world. You can also do so in a capital-efficient manner since futures traders don’t have to put up the entire amount of capital to “buy” or “sell” a futures contract. Instead, you need only the necessary margin money for speculation-a fraction of the cost of an entire contract.
Since the futures markets provide very high leverage for speculators, it is up to the individual trader to decide the amount of capital he or she wants to place in the account.
For example:
- Let’s suppose the cost of a single contract is $20,000. But to trade that contract, you may only be required to post $1,000, a mere 5% of the contract’s total value.
- If the market moves against you and your position begins taking on an unrealized loss, you can lose more than your initial $1,000, putting you in an under-margined position.
- If the market continues to work against you, you can lose more than you have in your entire trading account, depending on the severity or speed of the negative market move. So, be careful when using leverage
Likewise, if the market moves in your favor, you can also gain positive returns at a much greater rate because of the leverage you are using.
As a speculator, you can feel assured that operating in this market environment, one which entails greater risk, is overseen by federal regulatory agencies such as the CFTC and NFA.
For those of you who are unfamiliar with the latter, the National Futures Association (NFA) regulates Brokers, Introducing Brokers, Futures Clearing Merchants, Commodity Trading Advisors (CTAs), SWAP Dealers and Commodity Pool Operators. The NFA is a self-regulated organization (SRO).
Although these are separate organizations, they both operate together to stop financial fraud and protect the market from “bad actors.” In particular, both organizations are there to make sure that your funds as a speculator (or hedger) are fully segregated. This is key, as it means that your funds are held separately from the clearing firm’s operating capital. Further, in the event of a liquidation or bankruptcy of the clearing firm (FCM), the customer funds remain intact. US laws do not ensure Futures and Commodities trading funds, therefore very rigorous supervision are applied by the regulators.
Due to this high level of regulation, many institutions feel comfortable placing funds in clearing firms, and their high volume of trading creates the liquidity for the speculators, both large and small, to trade and speculate in the futures market.
Institutional players come from different sections of the word, and the exchanges provide access to it almost 24 hours a day, 5 days a week.
Profit From the Rise AND Fall of Futures Contract Prices
One of the main advantages of the commodity futures markets is the ability to go short, giving you an opportunity to profit from falling prices.
Therefore, it’s possible to gain from both the upside and the downside of the markets. Let’s take a step back and get some terminology out of the way here:
- Going long means that you are buying a futures contract to seek profit from its potential price increase.
- Going short means that you are “selling” a futures contract to seek profit from its potential price decline (after which you have to “buy” what you had sold in order to close your position).
Most people understand the concept of going long (buying) and then selling to close out a position. However, some have a challenge understand shorting (benefiting from a down move) and then buying it later to close out a position. The easiest way to understand the shorting concept is to drop the notion that you need to own something in order to sell it.
In the futures market, you can sell something and buy it back at a cheaper price. Think of this logically, if you buy something at $1 and sell it at $10, you have a $9 dollar profit. But, in futures and commodities you can sell something at $10 and buy back at $1. Either way, it is a gain of $9.
Let’s expand on the shorting side a bit, just in case you can’t wrap your head around it. How do you sell something you do not own?
When you buy a futures contract as a speculator, you are simply playing the direction. To be clear:
- When a commercial buyer purchases a futures contract, they are “locking in a buying price” with the intention of buying the actual commodity at a later time.
- When a commercial seller is going “short” a position (as in the case of a farmer selling short corn or wheat futures), they actually intend to sell the physical commodity at a specified delivery date, using the short position as a means to “lock in” a sales price.
- But when a speculator buys or sells a futures contract, they are simply playing the direction for potential profit with no intention of actually buying or selling the physical commodity.
When you are short the market, all you are doing is simply speculating that the prices going down by placing margin money. All you have to do is click the “sell” button when you think the market is going down. From there the market can go in your favor or not. Either way, after a “sell” you must “buy” the contract back. If the market went up after the sell transaction, you are at a loss. If you buy back the contract after the market price has declined, you are in a position of profit.
Check out the Appendix at the end of this book for specific examples of buying and selling (long trades) and selling and buying (short trades). All examples occur at different times as the market fluctuates.
No Pattern Day Trading Rule
Since we were talking above about stock indices, it is important to be aware that the Pattern Day Trading Rule for stocks doesn’t apply to the Futures markets.
- You do not need a balance of $25,000 in order to day trade.
- You can short the Market in Futures if you meet the margin requirement.
- You can trade as frequently as you wish.
- When you short you do not need to pay interest on any short sale.
Liquidity
Since the futures market concerns the global macroeconomic environment, it is trading nearly 24/5. Worldwide events are happening around the clock and the futures markets must allow speculators, hedgers and commercial players around the globe to adjust their positions at virtually any time of choosing.
As a futures trader you can choose your preferred trading hours and your markets. One thing that you should keep in mind is that even though futures markets offer almost 24/5 access, their liquidity may be different during different periods of the trading day.
For example: The stock indices on the CME are typically most active between 9.30 AM EDT and 4.00 PM EDT as it coincides with New York Stock Exchange hours. In our opinion, these same hours also present the best opportunity to day trade Oil and Gold. This is not a rule, because during certain periods these markets could be very volatile depending on economic releases and events across the globe.
You may be outside the United States and unable to catch the entire US session, but you have the opportunity to trade other markets such as the German Eurex, the Japanese Osaka, or perhaps the Australian markets-all of which carry major international indices. Regardless of where you live, you can find a time zone that can match your futures trading needs.
Diversification
Many investors traditionally used commodities as a tool for diversification. Futures can indeed help you diversify your portfolio as different commodities have varying correlations to the securities markets.
Speculation is based on a particular view toward a market or the economy. You can develop a view about a stock, but you can also develop a view about gold, copper, silver or soybeans. You can have a negative view or a positive view about any commodity, and you can go long or short any market depending on your view.
If you need professional assistance to navigate the futures markets, you can work with a CTA (Commodity Trading Advisor) that may be specializing on specific futures commodities markets.
Hedging
Although commercial hedgers are some of the biggest players in the futures markets, most of the liquidity comes from the smaller speculators. For instance, the rough rice market may be traded by “commercials,” but because of the lack of smaller speculators, it is not liquid enough to trade, particularly in the short term.
Chances are that you are not a hegder, otherwise you wouldn’t be reading this document. Although you may have next to zero interest of need for a hedging account, it’s important to know what hedgers do, and that because of their size, they have a greater capacity to move illiquid markets such as dairy, lumber, rice, and sugar.
Conclusion: So above is the How to Start Trading Futures | A Beginners Guide article. Hopefully with this article you can help you in life, always follow and read our good articles on the website: credit.huyenso.com
