The fundamental difference between forward and futures trading is that a forward is exchange-traded, while a future is not. The difference lies in the funding and margining of the futures. For example, futures are margined, while forwards are not. While both are exchange-traded, futures have considerably less credit risk.
A clearing house, which accepts both sides of the trade, guarantees against default and marks to market each night. Forwards are generally unregulated, while futures are regulated at the central government level. According to the Futures Industry Association, 6.97 billion futures contracts were traded in 2007.
Futures trading is not for everyone, and not all investors are qualified to participate. For instance, some investors are speculators who borrow substantial sums of money to play the futures market. Although this can lead to a larger profit than an investor would otherwise earn, it comes with a significant amount of risk. The market may move against speculators and they could lose much more than they initially invested. The CFTC has warned against individual investing in futures.
One benefit of futures trading is that it is a hedge against inflation. Large corporations will buy futures to protect against price fluctuations. They need large quantities of specific commodities to operate. For example, buying oil futures is more profitable than buying each individual stock. If you are a large corporation and need a certain amount of oil, purchasing each one would be too costly. In the long run, it is far more cost-effective to invest in a futures contract in oil, rather than buying each individual stock.
However, it is important to understand that trading futures involves significant investments in time and energy. This investment is not for the faint-hearted. It requires a substantial amount of time and effort to follow market trends, read commentary, and keep up with news.
Traders should avoid the temptation to floor the accelerator and trade multiple contracts at the same time. If you can handle just a few contracts, you will likely see a profit and reduce your losses.
Despite the inherent dangers, futures provide investors with the opportunity to speculate on the prices of underlying commodities without having to actually deliver the commodities. The actual delivery of a futures contract occurs for such a small fraction of the total number of contracts that it’s possible for an investor to profit from price fluctuations.
The majority of futures positions are closed out before expiration rather than actual physical commodities being delivered. Consequently, if you are new to the world of futures trading, the following advice will assist you in comprehending how futures markets function.
Trading futures involves fundamentals that are very comparable to those of trading other market-based assets. The supply and demand of the underlying asset in the future determines the price of the futures contract, just as it does in any other market.
Arbitrage will not be profitable if the supply of and demand for the deliverable asset are not in equilibrium with one another. As a direct consequence of this, the cost of futures contracts is subject to erratic swings. In this kind of situation, the price at which the market clears is lower than the value that is anticipated to be achieved in the future.
