How do futures work in trading today?

As the forex market continues to surpass any other financial sector on the planet, more businesses and consumers are entering the ranks of traders each year.

However, with the ongoing volatility in the market caused by a complex variety of situations, it is more important than ever to fully understand the sector before entering it.

One such area of growing interest is those who trade futures in UK markets in particular. In this post we will explore what futures are and how they fit into the already expansive forex industry.

What are futures?

In simple terms, futures can be categorised as a derivative financial contract between two or more parties. A transaction on an underlying asset is agreed upon and is then bought or sold at an arranged date, regardless of any active market conditions.

Assets can take many shapes and forms but some of the most commonly used are stocks, currencies, commodities and bonds to name a few.

The main benefit of futures is that investors can speculate on the current trend or direction of an asset and hedge the potential volatility of price movements, allowing better risk management to losses.

Overall, an investor will not take physical delivery of an asset but instead speculates on price changes of the course of a contract. Profits as well as any losses are then calculated once the legally binding contract has been completed.

Long or short?

Futures can usually be separated into long and short positions and both come with pros and cons.

For example, a trader wishes to speculate on the future value of oil. The trader can invest in a futures contract if they are confident the price of the asset will rise over the course of a contract. If the price of oil is higher at the end of the contract, the trader will then profit from the agreement.

The main difference between long and short positions is that a longer contract might offer a larger return over time, however, this can be riskier as the market value will have a longer time to fluctuate.

Short positions have a lower risk margin with more flexibility but also potentially lower returns.

The pros and cons

One huge benefit to futures contracts is most relevant to larger businesses who can hedge the overall cost of certain materials essential to their operation. This effectively protects them from any unexpected movements in the market. However, the disadvantage to this is that if the value of a certain material drops, the business is still contractually obliged to pay at the agreed amount.

Another advantage to this investment vehicle is that it only requires a fractional deposit of the contract amount. Again, this can also be a risk both the gains and any losses will be escalated.

Since many futures contracts utilise leverage, it is highly important that investors are fully aware of the risks in leveraging their positions.