Futures trading is a contract taken out between two parties who wish to exchange a certain commodity (or financial instrument) with each other, at some future date, at an agreed price and that price is set at the time they agreed to the contract. No matter what price the certain commodity will be fetching at that date, whether it is higher or lower, the parties will exchange it for the contract price. As a result one of the parties stand to make a profit, or loss, depending on the price of the commodity at the time compared to what it was worth at the time the contract was signed.
Beginnings in Agriculture
Futures trading is an age old practice that had its beginnings in agriculture when farmers sold their crops to a buyer, before harvest, at a negotiated price. If for some reason the bottom fell out of the market following the harvest, for example because of oversupply, the farmer was guaranteed his price and would come away better off than his neighbours. If on the other hand a storm had damaged many of the other crops in the area before the harvest and the crop of the farmer with an agreement survived unscathed, it would be worth a lot of money, but he couldn't capitalise on it, the person who had pre-brought his crop would. It was also a way a group of farmers growing the same crop could agree to only grow a certain amount in order to not flood the market and keep the price of their product stable.
Investors Don't Physically Handle the Commodities
The principle behind futures trading in agricultural products has been taken up by investors. These investors make a living out of buying a certain commodity at an agreed price and banking on its price increasing before it actually changes hands. They need not physically buy or sell the product themselves, just deal with the value of the product. The whole process of futures trading is based on supply and demand and the party selling the commodity is known as taking the short position while the party buying is taking the long position.
Investors using the futures trading method are required to deposit an amount from five to 15 percent of the commodity’s agreed value on making the agreement, this is called the 'initial margin.' It is often done as a hedge against any future price change thereby creating certainty and reducing risk. If the buyer locks in a low price they will benefit if the price rises in the future when they can then sell into a higher priced market and pocket the profit.
Many people who invest in futures trading make big profits but it also carries with it a lot of risk. If for some reason the value of the commodity were to decrease significantly before the end of the contract, a lot of money could be lost. It is a field where a lot of professional knowledge is required.
Kelly writes about forex trading online for Forex Trading Finder where you can compare foreign exchange brokers to get the best forex reviews.