Futures trade across six different types of assets, virtually around the clock. They offer traders with the flexibility to diversify their portfolios. Traders can also respond to events that occur outside normal stock market trading hours.
Futures can be fast-moving. They have a high degree of risk. So, education is essential for anyone interested in trading this product. To get started, let’s discuss what a futures contract is. We should also look at how futures are traded. Additionally, consider why individual traders are drawn to this investment type.
A futures contract is an agreement. It lets you buy or sell an asset at a predetermined price. This deal occurs at a specified time in the future. Futures contracts offer a way for market participants to offset the risk of a price change. They also allow participants to take on the risk over time. For example, let’s say oil is trading at $74 per barrel. A trader buys an oil futures contract at $74. He now has the right to buy 1,000 barrels of oil at $74. If the price of oil rises, the contract will be worth more. If the price of oil falls, the contract will be worth less. Thus, the trader assumes the risk and the returns linked to the fluctuations of the asset controlled by the contract.
A futures contract is a derivative, meaning it “derives” its value from an underlying asset. When you trade futures, you aren’t actually buying or selling assets at the moment. Instead, you have an agreement to do so in the future. By initiating the contract, you can lock in a price for the underlying asset. This means that whether the price rises or falls, you pay or get the original agreed-upon amount. Each contract is standardized with certain specifications about the underlying assets, like their delivery, quality, and quantity. In theory, when the contract expires, you’re obligated to get a specific quality of the underlying goods. You must also deliver the corresponding cash amount.
Futures are traded on a futures exchange. It is a regulated and centralized place. It facilitates the buying and selling of futures contracts. The exchange ensures that contracts will be honored. This eliminates counterparty risk. Counterparty risk is the risk that the other party won’t deliver on their part of the contract. The exchange gathers legitimate buyers and sellers on the same trading floor. This setup allows traders to easily enter and exit the market. Most futures products trade 23 hours per day, six days per week.
Futures offer traders leverage. This is the ability to take a position in an underlying asset. They do so by only committing an amount of capital that’s a fraction of the actual cost of the asset.
Many traders use leverage because of the profit potential. When you use leverage, you access the potential profit of an asset. Small changes in the underlying asset can lead to large gains. This includes assets like stock index futures. Yet, traders must remember that the opposite is also true—leveraged instruments can magnify losses.
Finally, many traders use futures to add diversification to their portfolios. Futures offer access to a wide variety of asset classes. Diversification strategies do not assure a profit. They can’t guarantee protection against losses in declining markets. Still, they are designed to reduce the overall risk of the portfolio.
Diversification does not remove the risk of experiencing investment losses.
Before we continue, note that to trade futures, you have to finish an application and meet certain requirements.
Now let’s discuss how this course can help prepare investors to trade futures. The course includes four lessons. This first lesson is designed to give you a bird’s-eye view of the futures market. You’ll learn some basics like what a futures contract is and how it works. You’ll also discover a brief history of the futures market and its participants. Additionally, you’ll explore some ways futures are used within a portfolio.
In the next lesson, you’ll learn more details about futures and futures trading. This includes characteristics of contracts, margin, and leverage. You’ll also learn how to calculate profits and losses. And of course, you’ll learn how to trade futures using the thinkorswim® paperMoney® platform.
In the third lesson, we’ll teach a strategy that uses futures to hedge a portfolio. When talking about futures, “hedge” can mean a couple different things. In portfolio management, hedging means entering a position to offset losses in another position. Futures allow a trader to take a relatively small futures position. This smaller position can help offset losses in a large portfolio.
We’ll walk through a sample investing plan. It will give examples of how a trader selects a futures product. We will show sample entry and exit points. Additionally, we will cover strategies for figuring out how many contracts to trade. The final lesson will recap what you’ve learned and help you decide your next steps.
By the end of this course, you’ll be capable of:
In the next video, you’ll see a brief overview of the futures market. Videos like the one below are throughout the course. They give helpful explanations. The videos elaborate on key details. They show how to practice strategies using the paperMoney platform.
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