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 a futures contract. A trade will realize an immediate profit with a move higher than the price you bought, but on the flip side, the trade will realize an immediate loss with a move lower than the price we bought. Margin deposit is required for every contract that is bought or sold. You need to understand the margin requirements for each commodity that you wish to purchase as margin requirements and contract specifications can differ greatly depending on the commodity. Another thing to remember is that leverage is the key to futures trading, understanding the leverage and contract specifications for each commodity that you become involved in is a must. Finally, make sure to remember to 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 regarding futures trading is why do people trade futures in the first place? The answer is pretty basic, it has to do with leverage. Leverage is the ability to control a large dollar amount of a commodity with a comparatively small amount of capital. Traders who purchase a futures contract are attempting to gain bullish exposure. On the other hand, traders who sell a futures contract are attempting to gain bearish exposure.
Using Leverage when Buying a Futures Contract
To give you an idea how leverage works in futures trading we’re going to look at the gold futures contract. Gold is one of the most popularly traded commodities, so it makes a good hypothetical. Let’s assume we expect the price of gold to move higher (we’re bullish) and because of that were going to buy a futures contract to gain bullish exposure. Now, when we buy one futures contract, it’s not really like buying one share of stock. One futures contract includes 100 ounces of gold. Let’s assume the current price of gold is $1,200 per 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 be required to put up a deposit. This deposit is approximately $6,000 for gold and is 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 for a total of $10,000 profit. Of course, it should be remembered, that the contract could have moved in the other directions and lost $100/oz which would cause a loss of $10,000. As you can see, using leverage we controlled a very large sum of gold, for a relatively small dollar amount in margin.
Before you start to invest in futures, take your time in learning and do you due diligence. We have a breadth of knowledge available at your disposal and we encourage you to take advantage of it before deciding to invest.