Things to Consider when Trading Futures Contracts
- Understand he leverage and specifications.
- Understand the margin requirement.
- Use stop loss orders.
Here are the key things to know when it comes to buying afutures contract. A trade will realize an immediate profit with a move higherthan the price you bought, but on the flip side, the trade will realize animmediate loss with a move lower than the price we bought. Margin deposit isrequired for every contract that is bought or sold. You need to understand themargin requirements for each commodity that you wish to purchase as marginrequirements and contract specifications can differ greatly depending on thecommodity. Another thing to remember is that leverage is the key to futurestrading, understanding the leverage and contract specifications for eachcommodity that you become involved in is a must. Finally, make sure to rememberto use a stop loss order to try and protect yourself.
Why Do People Trade Futures Contracts?
One of the most common questions that people ask regardingfutures trading is why do people trade futures in the first place? The answeris pretty basic, it has to do with leverage. Leverage is the ability to controla large dollar amount of a commodity with a comparatively small amount ofcapital. Traders who purchase a futures contract are attempting to gain bullishexposure. On the other hand, traders who sell a futures contract are attemptingto gain bearish exposure.
Using Leverage when Buying a Futures Contract
To give you an idea how leverage works in futures trading we’regoing to look at the gold futures contract. Gold is one of the most popularlytraded commodities, so it makes a good hypothetical. Let’s assume we expect theprice of gold to move higher (we’re bullish) and because of that were going tobuy a futures contract to gain bullish exposure. Now, when we buy one futurescontract, it’s not really like buying one share of stock. One futures contractincludes 100 ounces of gold. Let’s assume the current price of gold is $1,200per ounce, therefore the full contract value of the futures is $120,000,however we’re not expected to put up $120,000, instead we are going to berequired to put up a deposit. This deposit is approximately $6,000 for gold andis referred to as a margin. So, let’s figure we bought the futures contract at$1,200/oz and over the course it rallies up to $1,300. That would give us a$100/oz profit, multiplied by the 100/oz of gold that makes up the contract fora total of $10,000 profit. Of course, it should be remembered, that thecontract could have moved in the other directions and lost $100/oz which wouldcause a loss of $10,000. As you can see,using leverage we controlled a very large sum of gold, for a relatively smalldollar amount in margin.
Before you start to invest in futures, take your time inlearning and do you due diligence. We have a breadth of knowledge available atyour disposal and we encourage you to take advantage of it before deciding toinvest.
