A futures contract is an agreement to buy or sell an asset at a future date at an agreed-upon price. Futures contracts are standardized agreements that typically trade on an exchange. One party agrees to buy a given quantity of securities or a commodity, and take delivery on a certain date. The selling party to the contract agrees to provide it. The futures market can be used by many kinds of financial players, including investors and speculators as well as companies that actually want to take physical delivery of the commodity or supply it.
Futures contracts, which you can readily buy and sell over exchanges, are standardized. Each futures contract will typically specify all the different contract parameters:
The unit of measurement
How the trade will be settled – either with physical delivery of a given quantity of goods, or with a cash settlement.
The quantity of goods to be delivered or covered under the contract.
The currency unit in which the contract is denominated
The currency in which the futures contract is quoted.
Grade or quality considerations, when appropriate. For example, this could be a certain octane of gasoline or a certain purity of metal. If you plan to begin trading futures, be careful because you don’t want to have to take physical delivery. Most casual traders don’t want to be obligated to sign for receipt of a trainload of swine when the contract expires and then figure out what to do with it.
How do futures work?
Futures contracts allow players to secure a specific price and protect against the possibility of wild price swings (up or down) ahead. To illustrate how futures work, consider jet fuel:
An airline company wanting to lock in jet fuel prices to avoid an unexpected increase could buy a futures contract agreeing to buy a set amount of jet fuel for delivery in the future at a specified price.
A fuel distributor may sell a futures contract to ensure it has a steady market for fuel and to protect against an unexpected decline in prices.
Both sides agree on specific terms: To buy (or sell) 1 million gallons of fuel, delivering it in 90 days, at a price of $3 per gallon. In this example, both parties are hedgers, real companies that need to trade the underlying commodity because it’s the basis of their business. They use the futures market to manage their exposure to the risk of price changes.
But not everyone in the futures market wants to exchange a product in the future. These people are investors or speculators, who seek to make money off of price changes in the contract itself. If the price of jet fuel rises, the futures contract itself becomes more valuable, and the owner of that contract could sell it for more in the futures market. These types of traders can buy and sell the futures contract, with no intention of taking delivery of the underlying commodity; they’re just in the market to wager on price movements.
With speculators, investors, hedgers and others buying and selling daily, there is a lively and relatively liquid market for these contracts.
How to trade futures？
It’s relatively easy to get started trading futures. Open an account with a broker that supports the markets you want to trade. A futures broker will likely ask about your experience with investing, income and net worth. These questions are designed to determine the amount of risk the broker will allow you to take on, in terms of margin and positions.
There’s no industry standard for commission and fee structures in futures trading. Every broker provides varying services. Some provide a good deal of research and advice, while others simply give you a quote and a chart.
Some sites will allow you to open up a virtual trading account. You can practice trading with “paper money” before you commit real dollars to your first trade. This is an invaluable way to check your understanding of the futures markets and how the markets, leverage and commissions interact with your portfolio. If you’re just getting started, we highly recommend spending some time trading in a virtual account until you’re sure you have the hang of it.
Even experienced investors will often use a virtual trading account to test a new strategy. Depending on the broker, they may allow you access to their full range of analytic services in the virtual account.