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What is Futures Trading, Tips and Pros & Cons

What is Futures Trading, Tips and Pros & Cons

Are you exploring futures or want to learn about them to become a better trader? This guide provides you with everything you need to know about futures trading, why people trade in futures, its pros and cons, and some tips that help you to get more profits in futures.

What is Futures Trading?

It is basically a contract that offers terms for delivery or cash settlement of a specified asset like stocks, resources, or products at a specified date in the future. In a contract of futures, a buyer and seller are involved; a buyer has to pay a certain price on a preset date. However, a seller has to offer the underlying asset at the specified price. The price of the futures contract is derived from the price of the underlying asset that, makes futures a form of spin-offs.

For Instance

Suppose you have a farm and grow wheat, and you may want to bolt in a price for your wheat before it’s time to crop. It can assure a certain level of profits for the year, and there would not be any shock if the price of wheat collapsed. While it is also revenue that you would not gain, the profits of the price of wheat shoot up before harvesting time.

Why People Use Futures?

People use futures trading for hedging or risk management and speculation purposes.

  1. Hedging or Risk Management: Futures contracts bought and sold to get or deliver the underlying commodity are typically used for hedging determinations. Many institutional investors or companies frequently use it. As a way to help manage the future price of that commodity on their operations or investment portfolio.
  2. Speculating: The contract of futures is usually liquid and buy and sell up to the time of termination. It is a vital feature for speculated investors and traders who don’t own the underlying commodity and do not want to. They can buy or sell futures to direct an opinion about and profit from the direction of the market for a commodity. Then, previous to termination, they will buy or sell an offsetting futures contract position to remove any responsibility to the actual commodity.

Pros and Cons of Futures Trading

Like any other trade deal strategy, there are some benefits and drawbacks of futures that you should know before getting started. So, if you are a seasoned trader or novice, you will find these below-mentioned facts valuable.

Pros

  1. Simple Pricing: Prices in futures are based on the current spot price and adjusted for the risk-free rate of return till expiration and the cost to store commodities physically.
  2. Hedging: Investors use futures to protect unrealized profits or minimize losses. The wide selection of futures products available lets the trade take a cost-effective hedge against the broader market or specific sectors and individual commodities.
  3. Leverage: It is an investment strategy when you rent money to increase the return on an investment. Futures are traded with leverage on margin, letting an investor control larger positions with a small initial outlay. Yet, it can be an ironic sword if the asset price moves in the unintended direction. Traders must know that they can lose more than their initial margin in this trading.
  4. Variation: A futures contract offers a diversified portfolio of multiple assets for investors to trade, like stocks, indexes, commodities, crypto, currencies, and many more.

Cons

  1. Complex Procedure: There are some complexities involved in futures trading. Investors and traders require a good deal of time and effort if they want to be successful. It means they have to monitor the market and keep on top of the current events.
  2. Over-leverage: Leverage benefits you to amplify returns with less of a cash outlay. If the market turns against you, then you will be responsible for the full amount of the losses and be subject to the margin calls. Simply put, leverage also amplifies losses.
  3. Dealing with Expiry Date: Futures contracts have expiry dates that traders need to monitor. When the contract slants its expiry, its price may rapidly lose value or become worthless. To combat this, investor frequently rolls forward their contracts to an extensively dated one as the expiry date approaches.
  4. Physical Delivery: If you fail to close your position or you don’t trade them off into offsetting contracts over. Then, you take the risk of taking physical delivery of the underlying asset and pay the agreed-upon price.

4 Tips to Consider When Trading Futures

  1. Plan your Trade: Before executing a trade, make a plan for your strategy. It means having not only a profit objective but also an exit plan in case the trade goes against you. Moreover, feelings like fear and greed make trading decisions harmful to you. Because your emotions can make disastrous decisions like push you to leave a profitable position too soon or hang onto a losing one too long.
  2. Save your Positions: To make your commitment stronger, you should trade with stop-loss orders. It helps you to decide on a bailout point first and then set a stop at that price. Moreover, the OTO: One Trigger Other strategy lets you place a primary order and protective stop simultaneously.
  3. Be Patient: Don’t get so conclusive in the market actions that you lose sight of the bigger trading portrait. You should monitor the working trades, open positions, and account balances. But don’t hang on to every uptick or downtick in the market.
  4. Learn from Margin Calls: Margin calls frequently indicate an emotional attachment to a losing trade. Instead of adding funds or dropping positions, it might be wise to leave the losing trade. Cut losses, learn, and seek the next trading opportunity.

FAQs

Q: Is trading in futures profitable?

Ans: Yes, if you have a good investment decision mind, then you can make money in the future because, in the future, you are trading with 10 times as much exposure as with normal stocks.

Q: How to trade futures?

Ans: It depends on the broker and your account position; with that broker, you may be appropriate to trade futures and also need a margin account.

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