Futures trading have a very old history. Some years ago the producers of the commodities like wheat or rice or corn were being exploited by the dealers who will themselves fix the price for the produce. Soon the system needed legality and thus the futures trading contracts came into existence. Initially only few products were included in the list of trading items but now there are a number of products including metals that form a part of the trading list. Very soon even the businessmen started realising the advantages of entering into future contracts as a form of investment.
What is Futures Trading?
In simple swords these are investment by the traders on any commodity without actually holding the commodity physically. The traders buy the commodity of a particular amount of a particular quality at low prices predicting the price to go up in the future. Several traders across the world would be entering into such trading of commodities and they are basically paper investing and there is no physical transfer of commodities between the traders. The futures trading are usually done by either the hedgers or the speculators.
Hedgers are the actual producers of the commodities who try to use such contracts to protect themselves from any future dip in the prices. They will sell off the contract if he predicts a fall in price and after harvest if the price does fall he will be assured to get the profit on selling the contract.
Speculators who are merely investors or traders who make profit by selling the future contract he they believe that the price could fall or buy a contract wherein the prices are expected to rise in the future.
Meaning of Futures Contract
Futures contract is an agreement between two parties who agree to exchange a particular quality of a particular commodity at an agreed price on a particular date. The date is something in the future and is called future date. The buyer of this contract is called as Long and the person selling the commodity is termed as Short. The buyer is under the belief that the price of the commodity is going to increase while the seller thinks that the price might fall in future. The number of contract to be entered by a trader does not have a ceiling limit. He can enter in any number of contracts at a time.
Benefits of Futures Trading
High Leveraged Trading
The Futures trading is a very high leveraged aspect. Out of the total value of the contract the investor is paying only 10% of it. This gives him greater flexibility to trade high amount of commodities. If the prediction of the investor proves to be right then he gets to earn nearly ten times the amount of the contract. So the returns that you get for futures trading are very high as compared to any other investment.
Paper Trading
The futures trading for a speculator is just a kind of paper investment. Though the investment is in commodities there is no physical exchange of goods between the buyer and the seller. This gives the advantage of gaining more with no need for holding the stock and spending on its storage facilities. The futures trading are termed as a futures contract as it contains an expiration date.
Quick Money
Futures trading offer quick money for the investor as compared to any other cash market. This is because the amount involved in trading is 10 times the value of the contract and so if everything goes well and the investor prediction proves correct then he gets to gain more money than he would have in any kind of cash market. However he also will lose money similarly is his prediction is wrong which could be reduced to some extent using the Stop Loss Order option.
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Liquidity
Future contract offers more liquidity as the amount of the contract that is traded on the trading floor is very huge. There are many traders trading the futures on the NSE and thus there will be a number of buyers and sellers for a futures contract at any point of time. This also keeps the prices of the contracts under control and there will not be unusual higher price jump especially during the expiration of the contract. So the traders will be able to make quick money by making use of the futures contract.
Fewer Charges
The futures contract trading does involve some commission charges which are paid only at the end of the position. The commission charges depends on the type of services availed by the investors from the brokers. Online trading can charge very low commission while if the complete control of buying and exiting decision etc is taken by the brokers then the commission will be on the higher side. In any case the commission and other charges involved are less compared to other investment options.