Beginning in 1848 with the formation of the Chicago Board of Trade, the U.S. futures market has enjoyed a long and distinguished history. The futures market exists to help both producers and users of a commodity better control the risk associated with future changes in prices. The risk is transferred to speculators, who stand to profit or lose depending on how prices change. Today, every major commodity (including financial and currency instruments) can be traded in the highly regulated futures market.

- The U.S. futures market has a long history and tradition.

- The U.S. futures market helps producers and users of a commodity minimize their risks associated with changing prices, thus giving speculators a chance to profit by taking on this risk.

- The U.S. futures market is highly regulated to guarantee all contracts are standardized and honored.

- The U.S. futures market attracts a significant number of traders throughout the world, thus providing as much liquidity in the markets as possible.

- The U.S. futures market permits buying and selling of contracts, thus giving the trader the opportunity to profit as prices increase and decrease.

Origins of the Futures Market

To understand the futures market, it helps to know why it was created.

When food preservation, storage, and distribution were not what they are today, the futures market stabilized price fluctuations over the natural cycle of growing seasons with its surpluses and shortages. This benefited farmers and livestock producers as well as consumers.

Today, the futures market stabilizes and manages price volatility in grain, livestock, and other food products, as well as diverse markets including energies, metals, even international currencies and financial instruments that can fluctuate in value.

How Futures Trading Works

Futures are traded by buying or selling contracts that guarantee a future price.

Futures are primarily used by those with a business interest in a particular market. From a farmer growing thousands of acres of corn to a financial institution managing vast holdings, each will use futures to manage risk and fluctuations in value over periods of time.

Individuals may also use the traits of the futures market to do speculative trading on the fluctuations of futures contract prices.

Trade Example

Let’s use corn in an example of a speculative trade.

Corn futures are traded as contracts on the price value of one bushel. Each contract is for 5000 bushels. Money is made or lost on the movement of the price value. One tick of movement in corn is one quarter of a cent. Each full penny of movement in the price is worth $50 per contract traded.

Let’s say March futures contracts on corn are trading at $3.90 for the value of one bushel. If you believe the price will go UP, you BUY. You will be LONG March corn from $3.90. If futures contracts on March corn move up in value to $4.02, you will make .12¢. You SELL to exit the trade for a profit of $600. (50 x 12 = $600)

If futures contracts on March corn move down in value to $3.83, you would lose .07¢. You SELL to exit the trade for a loss of $350. (50 x 7 = $350)

Without having a business interest in any market, speculators in futures may trade on upside or downside movement. The basic trading principles are the same.

March futures contracts on corn are trading at $3.90. If you believe the price will go DOWN, you will SELL. You will be SHORT March corn from $3.90.

If futures contracts on March corn move down in value to $3.78, you will make .12¢. You BUY to exit the trade for a profit of $600. (50 x 12 = $600)

If futures contracts on March corn move up in value to $3.97, you would lose .07¢. You BUY to exit the trade for a loss of $350. (50 x 7 = $350)

Margin

The cost to enter a trade on a futures contract is the margin. Margin requirements are established by futures exchanges. The margin is a performance bond. It is an amount of money set aside to cover potential losses on the trade. When money in a trading account is applied to margin, it cannot be withdrawn. The margin is not the amount of money the futures trader puts at risk.

If you have $5000 in your account and you wish to trade one contract of corn, the amount of margin required (approximately $2000) will be set aside when the trade is opened. Margin requirements can range from several hundred dollars to several thousand per contract, depending on the market. Your account balance will fluctuate as your open positions gain or lose in value.

Your balance must always be sufficient to cover the minimum margin or your broker will contact you to deposit more money if you wish to keep your positions open. This is a status known as being on margin call. Because of margin requirements and other factors, it can be possible for futures trading accounts to drop below zero, a status known as being in debit.

While no broker can promise your account will never be on margin call or debit status, your broker should work with you to manage your account to your risk tolerances and trading objectives.

Risk vs. Reward

Futures market price levels fluctuate throughout trading. A trade may be in profit or loss status before the market moves substantially in one direction. The amount of money you put at risk is the amount you are willing to see the market fluctuate against you while a position is open.

A strategy for managing risk on a futures trade is the use of a stop. A stop is a trade order that will close a position when the market reaches the price designated as your maximum loss.

Let’s say you’re willing to risk $1500 to make $1000. That would be a 1.5:1 risk:reward ratio. If you were trading one futures contract on corn, a .20¢ move would achieve your $1000 profit target. $1500 at risk would be equal to a .30¢ move.

You go long on March corn. Your broker enters a BUY order for March corn. The required margin will be set aside in your account. Your BUY order is filled at $3.90. You are LONG March corn. Your profit target price is $4.10. A stop will be placed to SELL at $3.60.

If the price of corn reaches $4.10 without selling off all the way back to your stop level of $3.60, you will reach your profit target on the trade. Your broker will SELL at $4.10 to close the position and take .20¢ profit which has a cash value of $1000. If the market moves against your position and the price of corn backs off .30¢ from your entry point, your stop will be triggered.

Your trade will be stopped out if the price of corn reaches $3.60. An order to SELL will automatically be entered to close the position. Your loss is limited to the defined amount: $1500, equal to a .30¢ adverse move on one contract.

Futures vs. Equities

How does trading futures compare with trading stocks?

It’s as different as apples to oranges!

Trading stocks is about researching thousands of companies: Their products and services, reputation and potential, management and marketing.

Futures allow the trader to focus on price movement and volatility within defined sectors of markets and instruments.

Securities trading primarily focuses on asset appreciation. Futures may be traded on upside or downside movement utilizing the same trading principles.

Futures offer strategies that allow a trader to hedge a position and work both sides of a market.

Futures are highly leveraged, requiring the trader to put up only a small fraction of the value of the underlying contract. Significant leverage can lead to significant losses or gains.

Risk Disclosure

Futures and options trading have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Trade with risk capital only. This is neither a solicitation nor an offer to Buy/ Sell Futures or Options. The risk of loss in trading commodities and options can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains. You should carefully consider whether your financial condition permits you to participate in futures trading. In so doing, you should be aware that futures and options trading can quickly lead to large losses as well as gains. Such trading losses can sharply reduce the value of your investment. All information provided on these pages is for fair use. Normal copyright protections apply to all commercial use of any documents or information. System Select Group and Cytrade Financial LLC is not responsible for any loss due to inaccuracies in the information provided. Nothing presented here should be construed as investment advice or recommendations.