In finance, futures refer to a derivative contract between two players that binds them to buy or sell an asset at a predetermined price on an appointed date in the future. The underlying asset can be a commodity, financial instrument, currency, index, or interest rate.
Key Notes
- Futures trading is buying or selling contracts in advance on a financial exchange to profit from price movements in the underlying asset.
- Margin is the minimum amount of assets that must be in your account when executing a contract in futures trading.
What is futures trading?
Futures trading is buying or selling futures contracts on a financial exchange to profit from price movements in the underlying asset. As mentioned, futures contracts are agreements between two parties to buy or sell a specific asset at a predetermined price on a specified future date.
Futures contracts set the price of a commodity that will be sold in the future. In other words, it can be said to be a transaction in which the future value of a commodity is bought and sold. The opposite concept is spot trading.
Futures trading is a type of derivative product created by price fluctuations of commodities and has the disadvantage of higher risk compared to spot trading.
In futures trading, the terms of the contract are set at the time the trade is executed. However, the actual transaction between money and goods takes place in the future, negotiated by the contract terms. This method originated to manage the risk of price fluctuations in commodities but is now preferred for investors seeking high returns despite bearing the risk.
Example
Let’s say the orchard has apple trees that will bear fruit after six months. Person A signed a contract with farmer B to buy 100 apples at 5 dollars in 6 months without knowing the current average price of an apple. Let’s say the current price is 3 dollars. Six months later, the cost of apples was set at 3 dollars. Because of the already signed contract for 5 dollars per apple, Person A has to pay Farmer B with a loss of 2 dollars per apple.
Conversely, if the price of an apple in the orchard reaches 10 dollars, person A can purchase the apples with a profit of 5 dollars per apple. This time, farmer B loses 5 dollars per apple. As you can see from this example, estimating the range of losses in futures trading is difficult. However, on the other hand, because it isn’t easy to measure the scope of profit, it is a typical high-risk, high-return investment type.
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Futures trading advantage
Futures trading is an investment method with many advantages. The advantages of futures trading are as follows.
1. 24-hour investment
The futures trading market operates 24 hours a day without particular opening hours. As a cryptocurrency investor, you want to respond quickly to the constantly changing market news to make a considerable profit. Twenty-four hours of trading availability enables you to utilize the strategy suitable to the rise and fall of the price.
2. High yield
Futures trading can expect high returns by using leverage freely. Even if your seed money–starting amount–is inconsiderable, you can expect high returns if you take advantage of the leverage function in the futures market, which is widely accepted among users. However, you should always pay attention that leverage also carries a large risk of loss.
3. Spot price irrelevancy
Falling spot prices do not lead to direct losses. In spot trading, when the price of the coin you purchased drops, the value of your assets immediately decreases. However, futures trading allows you to invest not only in rising prices but also in falling prices–this is called short positioning. When you take a short position in futures trading when your targeted asset is on the decline, the value of your asset goes up. A distinctive difference of this perk from other investment methods: you can invest in rising or falling options.
Futures trading risk
The risks of futures trading are notorious even among non-investment laypeople. There are two factors for that.
1. Excessive Leverage
The biggest reason futures trading is considered risky is leverage. Because futures trading adopts a margin system, if you set a margin of 1 million dollar product with 5,000 dollars, you can purchase the 1 million dollar product even if you only have 5,000 dollars. Making big profits with a low seed is a temptation for everybody, but the loss is also enormous because the transaction is concluded with a larger amount than the money you actually have.
2. Liquidation price
The fixed liquidation price is also a risk in futures trading. Liquidation happens when your futures contract becomes irrationally unbalanced for you to maintain the risk. The liquidation order is automatically executed when your margin price equals the liquidation price and reaches the bankruptcy price. This means all the amount that you have invested can be liquidated.
Futures trading, which is traded with margin, is risky. Therefore, when trading futures, you must be vigilant against the risks mentioned above.
What is margin?
In futures trading, margin is the minimum amount of assets that must be in your account when executing a contract.
Just like making a deposit when you sign a lease on a new place, each margin for futures transactions differs in amount and ratio. So be sure to check before trading.
When a transaction is in danger of being liquidated, if the futures trading margin is filled, the liquidation crisis can be avoided.
How to trade futures
The concept of futures trading is complex, but the method is not difficult. First, let’s look at how to trade stock futures.
In stock market
First, open a brokerage account at a stock exchange with a broker. Since each securities company has different criteria for handling assets, check the one that suits you before opening an account to conduct a trade wisely. Opening a brokerage account requires a collateral deposit by buying on margin from the broker. The margin is set based on a rate by Reg T, regulation T, from the Federal Reserves, the Fed, which refers to the central bank of the U.S.
In cryptocurrency market
Cryptocurrency futures trading allows you to start trading with a lower margin than stocks. Thanks to this, it is good for beginners in futures trading and small investors. After opening an account, it is very simple. You can contract a call option corresponding to the right to buy futures trading or a put option corresponding to the right to sell.
At this time, the options are divided into ‘long position’ and ‘short position’ according to the type of transaction. Whether to trade a ‘long position’ or a ‘short position’ is determined based on the current price. If you expect the value of an asset to increase in the future, you have a long position; if you expect it to decrease in value, you have a short position.
Interested in trying futures trading now? Check out the YouTube video from BingX—How to Get Started With Futures Trading.
FAQs
What is futures trading?
Futures trading is a method of trading the future value of a commodity. The date to conclude the transaction and the amount to be paid for the transaction are contracted in advance, and the contracts are executed on the designated date. Securities, stocks, and cryptocurrencies are traded in futures.
Is futures trading legit?
It depends. Although futures trading is a completely legitimate method of trading, in the sense of maintaining the risk of the investor, it is wise to consider learning about the dangers. Futures trading can use a wider range of leverage than spot trading. You can use this to grow seed money and increase your return on investment. However, it is important to keep in mind that in the event of a loss, you may suffer a greater loss than if you did not use leverage.
How to trade futures for beginners
Even those who are just starting out in investing can start trading futures. However, futures trading requires careful calculation and strategy. If you try futures trading after gaining a lot of ordinary investment experience, your chances of succeeding in futures trading will increase.
