Futures Trading – How to maximize your profits
Futures trading is not for everyone. It can be quite risky and the transaction requires a good understanding of the underlying assets and the factors that affect their price movements. Although it began as a means of regularizing and organizing the market for some basic commodities, futures have now emerged as a speculative tool for investors.
Today, you can invest in futures of many commodities and securities, including gold, silver, corn, wheat, sugar, coffee, treasury bonds, currency and stocks, even if you have no business interest in any of these.
A futures trader has to face many risks. He can make substantial gains with a small investment but he can also suffer big losses just as easily. In spite of government regulations, futures trading is not a good option for novice investors, especially because the size of the contract is usually large. The availability of leverage can lure you into taking unreasonable risks.
For skilled traders, futures offer a very attractive opportunity to improve their portfolio returns. Many futures transactions are conducted daily with great success. These transactions aid different kinds of investors in achieving their investment goals.
Speculators stand to gain much more from a successful futures deal than from investing in stocks. This is because of the huge leverage that is possible in these contracts. The speculator only needs to invest a small fraction of the contract value initially. If his analysis turns out to be correct and the prices move in line with his expectation, then he can make a handsome profit from the deal. The prices move quickly in the futures markets and the opportunity for quick gains is much higher when compared with the relatively slower moving stock market.
The futures market also opens up a much wider window of opportunity for the investor by bringing in sellers and buyers from all over the world into the marketplace.
Investors and businesses looking to hedge their positions to lower their risk can benefit from the price insulation that a futures contract gives them. Typically, hedgers are people who want to counterbalance their existing investments with a futures contract or those who can lose a lot of money even from small price changes in the underlying commodity.
In our example, Starbucks needs to purchase coffee for its business on a continuous basis. Entering the futures contract allowed it to hedge against the future price rise of coffee from $1 to $2. By simply buying sufficient futures contracts to cover the cost of raw material, the hedger can protect his production costs from going up when commodity prices rise.
A seller can hedge the investment he has made in producing the commodity by securing a future contract to sell at a particular price. Even if the price declines in future, the hedger is insulated from the fall.
When producers and consumers hedge in this way, they base their investment on their thorough understanding of the commodity and its typical price movements. As they know about the production process and demand for the commodity, they are able to assess the future price with some degree of accuracy, which is critical for a successful futures trade.
As discussed earlier, traders can also use futures to exploit arbitrage opportunities in the market. They can invest in futures of different but related underlying assets or those of the same commodity but expiring on different dates to make a profit.
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