Contracts in the futures market are between a buyer and seller. The contract states that the seller must provide the buyer a very specific quantity of a certain item, such as grain, oil etc, for a price agreed today, but at a date in the future.
It is important not to get confused about what the word "future" refers to. Futures traders are not day trading futures prices, we are trading today’s prices, but the settlement is taking place in the future. So we buy if we think prices will increase and we sell if we think prices will drop.
If I buy (or sell) a futures contract today, I don’t have to hold it until the contract expires, I can simply decide to sell it (or buy it) in the market at the prevailing price. Futures contracts are bought and sold in the regulated environment of a futures exchange, such as the Chicago Board of Trade (CBOT) in the U.S. and the London International Futures and Options Exchange: (LIFFE) in the U.K.
Futures were originally developed to help offset the risks and uncertainties experienced by farmers and merchants due to the varying supply and demand for produce. Take for example a coffee bean plantation farmer. The price that he will receive for the beans will vary according to the vagaries of supply and demand. In a year when supplies are limited and demand is high, prices will be high. In a season when demand falls and the supply is plentiful, the price will fall.
The use of futures trading in the farming industry has many benefits such as allowing the farmer to be able to plan ahead as he already knows what kind of profit he can expect from his crop of say coffee beans. The price may not be the best and the merchant may make a killing but the risk is reduced.
By using a type of futures contract long before harvest time both the farmer and the merchant can reduce their risks by setting the price.
Today the futures market has changed quite a bit from the historical origins. There are now futures contracts on financial instruments such as stocks and bonds. broadly speaking futures contracts are split between commodity type products and financial type products. It is usually not that important because they are rarely held until expiration.
The CBOT was started in 1848 for the benefit of the farmers and merchants. The exchange was to regulate both the quality and quantity of the actual crop that was being traded. Today the CBOT offers many contracts on items like wheat, oil, silver, corn, bonds and soybeans.
The Chicago Mercantile Exchange (CME) was created in 1919 and has managed a futures market in such things as pork bellies, live cattle and the SP500 index.
In London the big financial futures exchange is the London International Futures and Options Exchange (LIFFE). Here financial instruments such as the FTSE100, the GILT and Short Sterling are traded, the exchange is relativily new and opened around 1982.
EUREX started life as the DTB, the German futures exchange. The DTB has always been an electronic exchange and started around 1990, when electronic exchanges were still considered to be inferior to the open outcry system.
The German Bund was a heavily traded financial contract and one of the biggest markets on the LIFFE.
Many markets in futures have very high volumes and hence very good liquidity, these are attractive markets for traders. The high leverage in futures means that profits can be made very fast when the market moves, however money can also be lost very fast. If you want to learn to trade futures, or are even thinking of trading futures make sure that you learn as much as you can before using real money.
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Ron Smith discusses the futures and commodities markets. The DOW is near its low of 8700 and there is additional strength to the downside. He tracks the S&P and the NASDAQ on the Wizetrade Commodities software charts and talks about how gold and silver are losing strength.
This daily segment is recorded from Wizetrade TV. You can watch Wizetrade TV by visiting www.wizetrade tv.com and entering your email address. Wizetrade TV is now in High Definition (HD). High Definition quality programming, including crisper, cleaner charts with high resolution video. Register for Wizetrade TV now!
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