Futures trading is all about trading Futures Contracts. Just what is a Futures Contract and how does it trade? A Futures Contract, also known as a “Forward” Contract, or even a cash forward sale, is a contract between a buyer interested in a specific product, and a seller intent on supplying the product on a future date for a specified price. Futures Contracts are formal agreements, obligating both the buyer and seller. Futures Trading is known as a zero sum game. Every dollar made by the buyer is a loss to the seller and vice versa. Prices that are too high or too low…either the buyer or the seller profits, but at the expense of the other. For example, if soy prices rise, the farmer benefits but the soy milk manufacturer suffers. If soy prices fall, the farmer suffers, but the soy milk manufacturer’s bottom line does better.
Futures trading takes place in two different ways. Commodities are traded at a Futures exchange, on the floor like at the Chicago Mercantile Exchange (CME), where there are open outcry pits. But Futures trading can also be done “electronically,” with an internet connection, where individual investors place their buy and sell orders straight from their desktop trading platforms, like Tradestation.
There are 2 types of Futures traders: hedgers and speculators. A trader who is a hedger would be a farmer, manufacturer, importer, or exporter. Hedgers create futures positions for the purpose of reducing the risk that the price of their commodity may fall. For example, a soy farmer knows his crop will be harvested in August. He negotiates a soy futures contract before the harvest at the current price in July for delivery in September, after the harvest. In July, the price of soy is high because of limited supply. Should the price of soy fall in September (when the contract comes due), because of a bumper crop, the farmers’ price is already protected. Of coarse, the farmer is taking a risk. Should there be no bumper crop in September, the price of soy would rise even further but the farmer is already be obligated to deliver soy at the price negotiated in July. He would lose the additional profit. In September there could be a bumper crop and the price of soy is lower than his July price. In this case he wins.
Speculators, on the other hand, are trading Futures for the sole purpose of earning a profit, not for protecting the price of their crop. Speculators actually comprise the majority of traders in most markets. Speculators are willing to assume risk in the hope that if they buy low, they can sell high (going long), or by selling high, they can later buying back low (going short). For example say the soy speculator knows that the weather has been a problem for months and the soy crop will be limited in September. The speculator is happy to buy the soy Futures contracts in July at the current price. He is betting that the price of soy will skyrocket and he will make a killing in September after the small harvests in August. Speculators provide the liquidity needed to fuel the Futures market. Without speculators, no one would take the other side of the hedgers contract. As in the example above, the farmer sells the soy to the speculator in July for the current price. The speculator assumes risk, hoping that by September, the delivery date, the price of soy has risen and he can make a profit at the farmer’s expense. What he prays doesn’t happen is that come September, the price of soy goes down, meaning that he over paid.
When there were no organized Futures exchanges, like the Chicago Mercantile Exchange (CME) for example, Futures trading was a far more risky situation. Contracts were drawn up between one farmer and one speculator. The contracts were signed wherever the farmer happened to be selling his produce, like farmers markets. There were major problems with these individual contracts. First, either the farmer or the speculator was capable of defaulting on the contract. Who would make sure that the buyer made payment or the seller delivered the commodity? If the speculator knew he was going to lose, he would not pay for his side of the contract. If the farmer realized that the price of oats had risen significantly, he would not bring the commodity to the pre-arranged delivery location. Instead he would sell the oats in the open market. Moreover, since these contracts were created between 2 parties, the speculator was not permitted to sell his contract to another speculator. Here’s yet another problem…there was no one who was able to certify the quality of the commodity delivered. Farmers would fulfill their end of the contract with lower grade oats, and the speculator had no recourse.
Since the coming of organized exchanges, it became the responsibility of the exchange to certify delivery, quality, and payment. Exchanges now require good-faith money with a third party to ensure contract performance,thereby reducing the number of contract defaults. Exchanges were also able to standardize contracts, stipulating terms, such as commodity delivery dates and product grades.
With the coming of organized exchanges, Futures trading has now gone far beyond just buying and selling of commodity contracts like wheat, rice, corn, and soy. Today, there are futures contracts available for many asset classes, including treasuries, energies, equities, and currencies. Futures are an asset class called “derivatives.” A derivative is a security whose price is derived from one or more underlying assets. For example, the S&P 500 Futures Contract has as its underlying asset — the New York Stock Exchange’s (NYSE) S&P 500 Index. The S&P 500 Index is one of the most actively monitored equity indexes worldwide. The index is comprised of the top 500 well recognized stocks traded on the NYSE. Here’s the problem with the S&P index, however…you cannot trade the Index. The CME created the S&P 500 Futures Contract that you can trade. And in the case of the S&P 500 Futures Contract, when the value of the S&P 500 Index appreciates, the S&P 500 Futures Contract appreciates with it and vice versa.
Now, Futures can also have a currency index as its underlying asset. For individual investors, the Currency Futures Market is designed for the small number of contracts that individual investors intend to trade. With Currency Futures, individual investors can trade the exact same currencies that are being traded in the Forex market, but trade on the CME.
Shadowtraders specializes in training investors in Futures Trading. Most other Futures trading education companies are engrossed in training only the S&P 500 Futures Contract, and specifically the Emini version of that earmarked to individual traders. Shadowtraders is much more interested in introducing its clients to many different Futures, including currencies, energies, treasuries, etc. We trade assets with volatility and liquidity. We know the days of the week that a particular Future trades, the times of day it trades, how many contracts are traded of that Future, whether you can or can’t trade it, etc. That is Shadowtraders specialty.
If you are tired of just trading the S&P 500 Emini, or you are new at the Futures trading game and want to find out more, attend a Shadowtraders Webinar on Monday nights.
Barbara Cohen has been a professional day trader for over 10 years and is the CIO of Shadowtraders. She has trained hundreds of students to trade the Futures Market with Shadowtraders trading seminar. Before you purchase any trading course, make sure you attend Shadowtraders Monday Night Webinar, and hosted by Barbara Cohen