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Futures And Commodity Trading Johnston Investment Management Pty Ltd does not give investment advice and we are not recommending the trading of futures. The product/s you trade should be your personal choice after you have investigated every aspect of trading it. We are licensed futures brokers and educate people on the technical analysis strategies used to trade the futures market. Our objective is to educate our clients and provide an effective futures brokerage service, as we believe that you are the best person to manage your investments and future. It's our goal to give people an unbiased view of all the trading vehicles available, including futures. Traders are attracted to trading futures by:
There are a lot of myths about futures trading among investors today. I guess that this is because they are marketed as a cheap way to trade using a high level of leverage. The misunderstanding of leverage is the greatest problem with futures trading. It is the use of leverage that makes futures so attractive to many traders once they understand it. We have clients trading futures at many levels from trading index futures longer term instead of shares to daytraders. Futures trading requires a higher level of knowledge and trading skills than shares. Futures trading is not new. It is a well accepted, century old procedure used in many commodities for protecting profits, stabilising prices and smoothing the flow of merchandise. For example, it has long been an integral part of the wool industry in Australia: producers, wool buyers, mill owners, and others have used it to protect themselves against losses due to price fluctuations. Now Futures trading is a vital part of the investment industry where buyers and sellers of an expanding list of commodities, financial instruments, and currencies, come together to trade. The trading is carried out in contracts of specific commodities for delivery at a future date. There are two major participants in futures trading :- Hedgers & Traders Hedging The primary purpose of futures markets, is to provide an efficient and effective mechanism to manage price risk. By buying or selling futures contracts, these contracts establish a price level now for items to be delivered at a later date. Hedgers may be farmers, businesses, miners, exporters, fund manages, etc. who wish to establish a known price level weeks or months in advance for products they want to buy or sell in the cash market. This futures position protects them against unfavourable price changes that might occur. For example, a fund manager may want to protect a share portfolio from an expected down move in the share market. A sold position is taken in the index futures market at an acceptable price. If the share prices fall and the value of the fund is reduced, a corresponding profit on the futures contracts will offset the losses and protect the value of the portfolio. Traders The Trader or investor is looking for the risks that hedgers wish to avoid. Speculators have no intention of making or taking delivery of the commodity. Instead, they seek to profit from a change in the price. They buy when they believe prices will rise; and they sell when they believe prices will decline. Long (bought) positions are entered into when prices are expected to increase. Short (sold) positions are entered into when prices are expected to decrease. Contracts Are Closed By Taking An Opposite Position. Very few contracts ever mature. Most are cancelled out by an opposite transaction. ( i.e. the seller buys back his sold contract or the buyer sells his bought contract.) If the seller buys back his contract at a lower price than his original sold contract he makes a profit on his futures. If he has to pay more to buy it back than he originally sold it for, he then makes a loss on his futures. Obviously the same applies to the holder of a bought contract only the procedure is reversed Traders are a vital component in the futures industry as they helps to provide active, liquid and competitive markets. The Clearing House All Contracts traded on a Futures Exchange must be registered with a Clearing House which, through its computer facilities, has a continuous and complete record of both sides of the market. All Floor Members must be members of the Clearing House. Associate Members and other large participants may become members of the Clearing House and open accounts by lodging cash, securities or appropriate guarantees to cover their operations. Risk Futures trading is considered to be high profit and high risk and it shouldn't be attempted by the novice investor. The risk is a direct result of the leverage, which is the same reason that futures are becoming so popular. It's the leverage and simplicity of futures trading that is attracting an increasing number of investors to this form of high profit trading. Once the risk associated with the leverage is addressed, futures trading becomes a valuable trading vehicle. Risk and money management are vital to any form of investing or trading, and futures trading requires specific money management strategies. Don't start trading futures until you totally understand the markets and you have a detailed trading plan. Traders are attracted by:
Futures trading is a ZERO game. For every buyer there is a seller; for every long there is a short; so for every dollar that is made there is a dollar lost; the market is a balance of judgment so that for every good judgment there is a poor judgment. (The cost of brokerage and tax are not allowed for in this example). Physical Delivery Physical delivery and cash settlement are two different means of settling a futures contract. For the most part, futures contracts are physical delivery. Generally, traders close out their position by buying or selling an offsetting position before settlement. Cash Settlement Some futures contracts are cash deliverable, which means that they are settled with cash at the time of expiry if still held open. Upon expiry, profits and losses are credited or debited to the account of the contract buyers/sellers in an amount equal to the difference between the contracted price and the final settlement price multiplied by the contract multiplier. Most are closed out before expiry. Stock index futures contracts are cash settled, as there is no physical delivery when the contract expires Margin At the end of each trading day, every customer's account is totalled and every purchase and sale is matched. Gains and losses are credited and debited to each account each day. If there is not enough money in the account, then you receive a margin call. Because futures contracts are highly leveraged, the trader must maintain a minimum amount of cash in his account known as a deposit. Spreads A futures spread involves buying one contract and selling another contract. The investor hopes to profit by any price discrepancy which develops between the two contracts. The Contract Unit Futures contracts have 4 components :- Three fixed components 1) A specific quantity of the commodity 2) A specific quality of the commodity 3) A set delivery date One variable component 1) A price agreed upon on competitive open outcry auction or computer trading systems. Daily Price Limits Futures contracts have maximum limits as to the amount (price) the contract can move during the day. The exchanges set these limits. The limits are stated in terms of the previous day's closing price plus and minus so many cents or dollars per trading unit. If a futures contract price has increased by its daily limit, there will be no trading at any higher price until the next day of trading. There is also daily limit down price. If a futures price has declined by its daily limit, there can be no trading at any lower price until the next day of trading. Options on Futures Contracts Put and call options are being traded on an increasing number of futures contracts. Trading options on futures allows the speculator to participate in the futures market and know in advance what the maximum loss on his position will be. The purchase of a call entitles the option buyer the right, but not the obligation, to purchase a futures contract at a specified price at any time during the life of the option. The underlying futures contract and the price are specified. The purchase of a put option entitles the option buyer the right, not the obligation, to sell a specified futures contract at a specified price. Keep in mind that the profit realized with an option strategy is reduced by the option premium. The option's price is determined in the same fashion that an equity option is determined. Selling Options Options are sold by other market participants known as option writers, or grantors. The reason people write options is to earn the premium paid by the option buyer. The option writer hopes that the option expires worthless. When this happens the writer retains the full amount of the premium. If the option buyer exercises the option, however, the writer must pay the difference between the market value and the exercise price. The possible loss to the option writer is unlimited.
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