In 2021, futures trading rose to reach 29.28 billion contracts worldwide.
As more people have taken up investing, the interest in futures has also gone up. They offer certain advantages over other markets such, as stocks and bonds, but understanding the futures market isn’t easy.
So what is the futures market? Keep reading for a rundown of everything you need to know.
What Is the Futures Market?
The futures market is an auction market that allows people to buy and sell futures contracts and commodities. There are various futures markets available, such as the NYMEX (New York Mercantile Exchange), CME (Chicago Mercantile Exchange), and Cboe (Cboe Options Exchange).
Futures markets originally took place in trading hubs in various large financial cities such as London, Chicago, and New York. Like many exchanges, they would involve hand signals and open outcry within trading pits. These days, such markets have become almost entirely electronic.
What Are Futures Contracts?
Different markets are available for trading different assets. The stock market is for trading stocks, the forex market is for trading currencies, and the futures market is for trading futures contracts. But what exactly are futures contracts?
Futures contracts are derivative agreements that are tied to specific assets or securities. The agreement dictates a future trade of the commodity at a pre-specified price.
Much like an options contract, a futures contract will have a buyer and a seller. One difference, however, is what happens when the contract expires. Options may become worthless at this point, whereas futures contracts don’t.
At its expiry, the buyer of a futures contract must buy and receive the asset, and the seller must provide and deliver it. One of the main reasons that commodity producers and suppliers create futures contracts is to avoid market volatility. Whenever someone invests in futures, they’re taking on the potential risk and reward that comes from this volatility.
Beyond traditional assets, futures trading now also involves trading and hedging financial products, as well as future values of interest rates. Suppliers and producers can make futures contracts when interest is increased. This isn’t the case with other securities.
Major Futures Markets
There are multiple futures markets, with the larger ones using their own clearinghouses. This allows them to generate revenue when people are trading through them, and from their own trades.
CME Group Inc. is the largest futures exchange in the world. It’s made up of the following exchanges:
- COMEX (Commodity Exchange Inc.)
- CBOT (Chicago Board of Trade)
- KCBT(Kansas City Board of Trade)
- The NEX Group
ICE (Intercontinental Exchange Inc.) is a global exchange that’s entirely electronic, and Eurex is another large worldwide exchange, though it primarily operates in Europe.
Some futures exchanges use external clearinghouses, with Cboe being one of the largest. On top of revenue from trading and processing fees, some exchanges make more money from charging membership fees to traders and firms.
Why Trade Futures?
The ultimate goal of trading futures is the same as any other exchange – to generate profits. For many, this means making trades based on how they think the market will go for specific commodities. Many people also use futures for hedging.
Successful trading isn’t easy. It takes a lot of time to learn how the market works and get used to figuring out what makes trades good or bad. Fortunately, there are various pieces of trading software available that can help you with the futures market.
At Affordable Indicators, we offer a range of NinjaTrader indicators that can help investors whether they are new to trading, or have years of experience. Spotting and analyzing market indicators is very tricky, but our indicators for NinjaTrader make it far more simple and efficient.
The NinjaTrader Order Flow Indicator, for example, allows users to view the market using order flow data. It’s highly efficient and can have a huge impact on your trades.
We sell many of our tools as complete packages, or you can choose from various NinjaTrader add-ons to build a more personalized experience. This way you can craft a system that’s perfectly suited to your trading strategy using different NinjaTrader custom indicators.
Pros of the Futures Market
Many people look to the futures market when first entering the world of investing. Some also transition to it from other markets. Either way, it’s important to know the benefits of trading on the futures market over other options.
Leveraging is an investment technique that involves using borrowed money to make a trade. The advantage of doing this is that, if done right, you can generate significantly larger profits than you would otherwise be able to.
Different markets vary in terms of how much of an asset you need to pay for yourself. With futures, this margin is usually between 3% and 10% of the contract value. This means you have the potential to make some very sizable profits even if you don’t have a lot to invest initially.
One of the first lessons to learn about investing is that you should diversify. If you put everything into one asset, and that asset loses its value, you’ll lose a lot of money.
With futures, there are various ways you can diversify your portfolio. You’ll have access to underlying commodity assets against secondary market products. There are also various assets you can invest in that aren’t available in other markets.
Risk is a big factor when investing. If you want to manage the risk associated with events that could affect the markets, futures are one of the best types of assets to be trading.
Short selling is a way of taking advantage of the dropping price of an asset. You can sell something for a certain price, and buy it back later for less. The margin requirement for short and long positions for futures doesn’t change or have any additional requirements, allowing you to take a bearish stance.
When you make profits trading futures, you’ll pay tax on a 60/40 basis. This means that 60% of your profits will be taxed as long-term capital gains, while the other 40% is taxed as normal income.
With the stock market, however, you’ll pay 100% of profits as ordinary income tax for any profits held for under a year. The tax rate for income tax is generally higher than capital gains tax, and capital gains tax won’t push your overall income tax into a higher bracket. The higher the percentage you have to pay as income tax, the more it will eat into your profits.
Cons of the Futures Market
While the leverage of the futures market can prove very beneficial, it also puts you at a greater risk. If a trade doesn’t go your way, you could lose a lot more money than you originally invested.
Many markets operate at specific hours, and outside of these no trades can be made. The futures market operates 24 hours a day, so prices are always changing and investors can buy and sell at any time. The issue with this is that no one can monitor the market at all hours of the day, so there are times that you may miss out on good opportunities.
The SIPC (Securities Investor Protection Corp) insures various types of investments to help if brokerages fail. Futures are one of the types of accounts they don’t protect, so you may be at risk here.
How to Trade Futures
The first thing you need to do is determine which market you want to trade on. There are plenty of choices, so you should look into some of the different options and see how they vary.
You’ll need to find a broker that supports your chosen market. They might ask for some information like your investing experience, net worth, income, etc. This will allow them to get an idea of the risk they should let you take on.
With some sites, you can trade with “paper money” first so that you can give futures trading a try before using any real money. Paper trading is a good way to assess your knowledge of the market, and it’s good to practice this way before you really get started.
Even after you’ve got some experience, it can be good to go back to paper trading if you want to try out any new strategies. Once you’ve got the hang of things, you can start investing real money.
You’re no longer wondering “what is the futures market?”, but it’s important to realize that no matter how well you understand it, there’s always more to learn.
Whether you’re just getting started, or have years of experience, using trading tools can help you make the best choices. At Affordable Indicators, we offer some of the best NinjaTrader indicators available. They can improve your strategies and help you maximize your profits.
If you have any questions about what we offer, click here to contact us today.