Futures trading has a target to make a profit by purchasing assets at a low price and selling them at a high price, or vice versa. Even so, markets can be uncertain and dynamic. The traders must stay alert and be ready to adapt their strategies.
This is a very high-stakes business requiring cool heads, fast yet well-thought-out decisions, careful analysis, and expertise. Futures trading is a place of potential risk, reward, and uncertainties, so adaptation and growth are constantly needed for success in this business.
The investor can hedge a price at which they are going to buy or sell an asset in the future by purchasing futures contracts. The contract buyer commits to buying an asset at a predetermined future date at a predetermined price, called the ‘strike price’, and the contract seller commits to delivering that asset at that agreed price.
How does Futures Trading work?
When delving into the concept of futures trading, the first thing to comprehend is the operation of the market. In other words, it is a market where traders can purchase or sell contracts that assure the purchase or sale of a commodity or a financial asset at a specified price on a specified date in the future. Such commerce is practiced in markets such as Multi Commodity Exchange, Intercontinental Exchange, and so on.
Purchasing a futures contract by a trader means that they are reserving the option of buying a certain commodity or financial security for a given price at some date in the future. On the other hand, in case one sells a futures contract, they are allowing someone else to purchase that indicated asset on a specific date at a previously set price.
The prices of these contracts are governed by the economic principles of supply and demand and other conditions such as climate, geopolitical changes, and economic dynamics also pose variations in prices. The first or primary price that is charged for such a contract is known as the initial margin.
When there are a few days left to the expiry of the contract, the price attached to the contract will however be adjusted to reflect changes in the price of the underlying asset. In the event, that the value of the asset appreciates, the holder of the contract is likely to gain, while in the contrary case, a loss will be incurred.
As the contract approaches termination, there are some choices traders can take. Delivery of the commodity in question can be taken, or they can open an opposing position in order to close their position and avoid delivery before the expiration of the contract.
Types of Futures Trading
There are two types of people who trade in futures: hedgers and speculators. Let’s see what quality makes them unique:
1. Hedgers
Hedgers are generally businesses such as wholesalers, retailers, manufacturers, or other companies that use futures contracts to protect themselves from future price swings. Hedging is very appropriate for those who need to own or use a commodity physically since it avoids the risks of price changes.
It appears that hedgers are interested in trying to minimize risk rather than attempting to make a profit. Indeed, there is hardly any chance of profit from hedging but can reduce uncertainty bound with price fluctuation very much.
2. Speculators
A speculator is a smart investor who does not have any interest in the real asset itself. He invests solely with the view to gain profit on market fluctuations through the sale and purchase of contracts. It is, in other words, gambling on the fluctuations of the price and reaping on the volatility.
They are usually seasoned traders and have a decent knowledge base of technical as well as fundamental analysis. Speculation is highly risky and may offer huge returns, but potential losses can be really huge, too.
Advantages of Futures Trading
The advantages of futures trading are as follows:
1. Hedging: Futures trading can be used as a hedging against price movements. Futures contracts enable a trader to hedge himself against potential losses in the underlying asset.
2. Price Discovery: Futures markets offer a means by which the expectations of buyers and sellers concerning future prices are expressed.
3. Leverage: It’s a fraction of the value that represents the asset and this will allow you to control a much larger position on a futures contract, meaning you are able to make more money, but remember the same amount of risk goes into your pocket, so one must be careful.
4. Liquidity: Futures markets in India, for example, the National Stock Exchange and Multi Commodity Exchange, are very liquid. You can easily buy and sell the order with considerable trading activities without affecting the price much.
5. Speculation: Futures markets permit revenue based on short-term price changes without having a claim on the underlying commodity.
6. Ease: Futures contracts have standard terms and expiry dates, which make them easy to trade. Also, there are many sizes and terms, so you can always adjust your trade to match your needs.
How to Start Futures Trading?
You can start futures trading in the following steps:
1. Set Up a Trading Account – To get started with futures trading, the first step you need to take is to set up an account with a trustworthy and registered broker.
2. Login – You can access your account through the broker’s trading portal or mobile app, and there you will find different options for futures and options trading.
Do your homework before you take any position; you could research what the different options are in the contracts to see which would best support your goals and risk thresholds.
3. Check the spot price – The spot price is the currently prevailing market price of an asset like a currency or commodity. This is the starting benchmark for any buying or selling decisions you may make.
4. Place Order – Enter your order details and purchase the futures or options contracts at the selected strike price.
FAQ’s
Q1. What are the risks associated with Futures trading?
A1. Futures trading carries some risks. It has the unpredictability of the market, and leverage tends to increase losses. It will also include the possibility of problems with the other party, and you can experience events that you did not expect to happen in a market.
Q2. Can you trade Futures on any asset?
A2. You can obtain futures contracts on anything: commodity trading in gold, crude oil, and agriculture items, equity indices like the Nifty 50, currencies, and rates of interest. Which set of contracts are offered at what exchange and with which broker can be a bit different.
Q3. What is the tax implication on Futures trading?
A3. Futures trading attracts the same kind of business income tax as any other business. That means if you make profits, they fall under your income tax slab. You can also consider all the expenses incurred because of your trading activities while filing your tax returns and, in case of a loss, which can cut down your speculative gains. However, you may face additional transaction taxes like Securities Transaction Tax and Commodity Transaction Tax.
Conclusion
In conclusion, futures trading is an advanced tool for diversifying your investment portfolio and potentially increasing your profits. You could apply this trading in reducing the risk and hedging of losses in other investments through your knowledge of market information and educated guesses concerning future prices.