Learn The Stock Market Lesson – Futures Trading – What are Futures?
Futures are not “direct” securities like stocks or bonds. They are examples of derivatives. Dr. Alexander Elder wrote in his second book, “Come Into My Trading Room,” that nine out of ten traders go bust in their first year. Futures offer traders some of the best rewards, but of course, with high risk to them. Like options, beginners tend to avoid futures because of its risk. Although futures might look dangerous at first, the actual danger lies within the people who trade them. As Elder states, “futures do not kill traders—poor money management kills traders.”
When you buy a stock, you own a part of the company. With futures, you do not own anything, but rather you enter into a contract for a future purchase of merchandise. These contracts deliver a specific quantity of a commodity by a certain date.
What is the difference between a futures contract and an options contract?
A futures contract is binding on both buyer and seller as opposed to options, where the buyer has the right but is not obligated to take delivery.
In futures, if the market goes against you, you have to keep adding money to your margin or get out of your trade at a loss. In order to exit the commitment before the futures contract’s delivery date, the holder of a futures position has to offset his/her position by either selling a long position or buying back a short position. This would close out the futures position and its contract obligations.
Like options, there are two main reasons why investors use futures: to speculate and to hedge (reduce risk).
Keep in mind that the main difference between futures and options is that an option grants the trader the right, not the obligation to fulfill the contract, whereas both traders of a futures contract must fulfill contract by the delivery date.
