A futures contract enables traders to trade an underlying asset at a predetermined price and future date. The underlying asset might be anything from stocks to currency pairings to commodities (like gold or oil). Futures contracts are frequently used for hedging or speculating and are traded on exchanges like the Multi Commodity Exchange of India (MCX) or the National Stock Exchange of India (NSE). In a futures contract, delivery and payment are actually made at a later period, but both parties agree to acquire or sell the underlying asset at the agreed-upon price and date. This mechanism aids in lowering the risk brought on by changes in the underlying price. A beginner may come up with a question: How do I trade in futures? This article will answer such questions. Read on and find out more.
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The Art of Buying and Selling Futures Contracts
Buying and selling futures contracts is easy if you follow certain steps.
- Open a trading account, become familiar with the fundamentals, and learn about futures.
- Understand how futures contracts work, the different types of futures contracts available, and the risks associated with them.
- Choose a broker who participates in the exchange you want to use for trading. They will help you execute your trades and give you the essential trading and research tools. They will assist you in the execution of your trades and provide you with the necessary trading and research tools.
- Invest money in your trading account to meet the margin needs for the futures contracts you want to trade.
- Use the trading platform provided by your broker to make an order for the relevant futures contract. You can give the contract information and the quantity, and you can pick between a buy or sell order.
- Keep a tight check on the market and the underlying asset’s price changes.
- To control your risk, adjust your position as necessary.
- Put in an order to terminate your position once you are prepared to stop trading. Your trading account will be credited or debited with the resulting profit or loss.
- A thorough understanding of the principles of futures trading as well as the dangers involved because it can be extremely leveraged. Learn about options trading and start trading confidently.
Understanding the Settlement Process for Futures Contracts
All futures contracts have an expiration date at which they must be settled. If a trader still has an open position at expiration, it will be settled automatically. The two ways of settling the futures are by physical delivery or by cash settlement.
Physical Delivery
In the physical delivery settlement, the seller provides the underlying asset when the buyer has paid the agreed-upon price. This type of settlement is seen in stock futures.
Cash Settlement
This approach entails paying the difference between the cost of the futures contract at the time of expiration and the price at which the contract was purchased or sold. The difference is paid in cash by either the contract’s buyer or seller. The financial futures markets for stock indexes and currencies tend to use this strategy more frequently.
Strategies to Trade Futures
While executing any trading strategy, it’s critical to have a good grasp of the risks involved as well as the mechanics of futures trading. A well-diversified portfolio and limiting the amount of cash exposed to any one deal are also advised. It is possible to buy and sell futures contracts using a variety of tactics. The following are some of the tricks:
Hedging
To protect against changes in the underlying asset’s price, futures contracts can be used as a hedge. For instance, a shareholder who owns shares of Tata Motors and anticipates a drop in the stock price may sell its futures to mitigate any prospective losses.
Speculation
Futures contracts can also be used speculatively, with traders purchasing or disposing of contracts in an effort to profit from changes in the price of the underlying asset. Traders may speculate on futures based on the prevailing trend. If the price of the underlying asset is heading upward, the trader buys a futures contract; if it is trending lower, the trader sells the contract.
Trading Spreads
In this approach, two linked futures contracts—such as two separate commodities or two different months of the same contract—are concurrently bought and sold. Profiting from the price differential between the two contracts is the aim. Our options calculator is a valuable tool for both beginner and experienced traders.
Contrarian Trading
By acting in the opposite direction of the market, this technique involves purchasing when it is selling and selling when it is buying.
Perks of Buying And Selling Futures Contracts
- Futures trading offers the chance to increase prospective profits by enabling traders to control a sizable portion of the underlying asset with only a modest amount of capital.
- Investors can diversify their portfolios beyond conventional stocks and bonds by trading futures, which gives them exposure to a larger variety of assets and markets. Futures markets have standardised contracts and a centralised exchange and are transparently run. For traders, this offers a certain level of safety and security.
- Because of the high level of liquidity, it is easy for traders to enter and exit positions quickly. In order to help them make informed trading decisions, traders who engage here have access to a multitude of information, such as market data, research, and analysis.
- The hedging mechanism helps lessen their vulnerability to price risks in the underlying asset.
- The market hours for the futures market vary from segment to segment.
- Due to the lower cost of trading compared to actual ownership, it may be a cost-effective approach to obtain exposure to the underlying asset.
Drawbacks of Futures Trading
While there are many benefits to trading futures, there are also many drawbacks to take into account.
- It can be complicated and calls for a solid grasp of the market’s workings and the risks involved.
- Leverage can increase possible earnings, but it can also increase potential losses. If their deals go against them, this may cause traders to sustain huge losses.
- Futures markets have the potential to be very erratic, with swift and unpredictable price changes. For traders who are not ready for abrupt market movements, this could lead to significant losses.
- By betting on a drop in the value of the underlying asset, traders can take short positions. Not many traders should use this method because it might be very risky.
- Trading futures can be expensive, including transaction fees and margin requirements. Also, traders must deliver or purchase the underlying asset if they retain a short or long position in a physically settled stock futures contract if it expires. The assets may be tendered to the proper clearing body by those who already own them. This can incur additional fees in addition to being logistically difficult.
