Trading on the stock exchange can be a risky, albeit highly profitable, endeavour. To trade using a futures contract is to play with the concept of both risk and conservatism. A futures contract encourages the adventurist nature of speculators who are willing to gamble of the probability of their items increasing. However, using a futures contract can also allow hedgers to protect their assets and future outflows from the volatile nature of the market. This article will provide information on why using a futures contract can be beneficial.
The future on a stock market investment is known as a contract, but it is founded on agreements where one of the parties promises to make a purchase of items or instruments at a specified date at a particular price. The specified purchase/sales price is dependent on the rates on the day the contracts are entered into and that the other party commits to selling on the quantity of the predetermined prices.
Futures contracts can be used by both speculators and hedgers, but they are a particular favorite of speculators because of the high liquidity. The underlying assets as part of the contract are, by nature, high probable to be sold because they are in high demand constantly. For example, high-demand commodities such as coffee, rice, cotton, oil, or minerals are traded with futures contracts. The assets will be traded in stock exchanges with bills and bonds to increase the speculated increase of commodity stocks and speculator profit.
Unfortunately, the prices can be profitable but present with a susceptibility to repercussions of shifts in supply and demand. This means that there is a risk associated with future contractors regarding the chance of profits being as high as the chance of losses. For example, if you were to purchase a future contract where you promise that one year from today a 1000 barrels of crude oil will be sold to you at the current price of $50; assuming the margin remains the same at 10% you will need to pay at least $1000 for the futures.
If, for example, the barrel purchase example increases in price to $60 per barrel then you can make a profit because the market price will increase as well. On the other hand, if the price decreases from $50 to less than $50 before the purchase date you will make a loss. This is the risk that a speculator will take when choosing to use a future contract.
As a hedger, the use of future contracts in stock exchanges and trading can be beneficial because of its high credibility. A hedger, as is stated above, will prefer to invest in the futures system because of the there is a credibility regarding delivery or settlement of trades. People who deal with exports or imports will benefit from this protection because they can be assured payment when the settlement date arrives. This is particularly useful for individuals who are looking for protection against price risks among commodities and foreign currency trading.