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What Is Futures Trading and How to Make Money with Them: Definition and Examples

What Is Futures Trading and How to Make Money with Them: Definition and Examples
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Contents:

1. The History of Futures Orders: Who Invented Futures Trading

2. Futures’ Features and Main Rules of Deals
2.1. Futures Definition and a Short Insight: Main Terms of the Market
2.2. Cash-Settlement and Physical Delivery Futures – Contracts with Different Features of Fulfillment
2.3. Modern Exchanges or How to Sell Weather Futures – Examples

3. Figuring out Futures Ticker: Marking Formation from A to Z

4. How to Make Money with Futures
4.1. Futures as Insurance from Price Rise or Fall: A Tool for Sharks of Macroeconomics
4.2. Speculative Operations with Futures: Money from Nothing and Skills to Cope with a Situation
4.3. Arbitral Operations with Futures: Multiway Interexchange Deals

5. Futures and Options – What to Choose?

Time has its own rules: technical progress leads to appearance of new affairs, professions, terms. Futures are the tool which was commonly unknown several years ago. But a sharp run in this direction was provided by the worldwide spread of the Internet. It caused interests, activities, professions and even sources of income which couldn’t be imagined a few years ago. It made specialties that couldn’t be dreamed of possible. Take at least, exchange trading: it’s approachable to operate with securities or resources gaining money from million orders either for an older person, or for a hillbilly bone from the rural remote, where it’s not quite good with culture and education.

Surely, successfulness in both cases is provided by self-education: you are not supposed to be taught to trade at the real exchange either at school or at the university. And with those who decided to master this tough but profitable stuff, we’ll figure out the following:

  1. What is futures;
  2. What is futures trading simply;
  3. Which terms are needed to work with futures;
  4. What principles lie in futures price formation;
  5. What role does this tool play in the world economy;
  6. How are most popular; futures sold and purchased;
  7. How can this information be transformed into personal income.

The History of Futures Orders: Who Invented Futures Trading

In order to give the answer to the question what is futures trading, I will need to bring my reader to the past, when this derivative (more information about this type of tools you can find in the article “TOP-5 Tips to Make Money with Binary Options – Step-By-Step Instruction for Trading”) emerged. Until the middle of 19th century, trading was engaged directly: producers and workers of rural remote periodically came together at large-scale trading (analog of annual mass rural fairs), where they tried to find a customer for their production. Gaining money, for example, for flour, a farmer bought tools and household items, household goods and fabrics, leaving minimum amount for everyday expenses until the next harvest. Producers of corn and vegetables were in the most unprofitable situation then. They couldn’t count on incomes until the next fall, and amounts of profits were often unpredictable. Good weather, rich harvest and high quality of goods in theory had to give reasonable incomes. But really, such great conditions raised productivity at neighbors’ fields: supply at the “fair” began exceeding demands, competitors broke prices in order to sell at least anything (this process is called “dumping” in economics), and as a result, forecasted enormous profits turned into covering debts that had been accumulated for the year. The situation was just slightly getting better even if the weather was on the side of a producer: merchants couldn’t orientate in opportunities momentarily and rarely sold their goods with the adequate labor price. To cut it short, if mechanics of selling futures orders couldn’t be formed itself, it should be invented. In 1848 in Chicago, there was the first officially confirmed order made with the promised harvest. The item of trading was corn.Futures history

So what is futures trading simply? Futures stay for the future. Futures is the promise of a deal. It’s a spring purchase of fall harvest, which is confirmed with documents:

  1. A producer calculates their opportunities and schedules growth in spring;
  2. Then, they offer to buy future harvest, guaranteeing they won’t set the higher price further and won’t agree at conditions of a more generous customer, leaving the counter agent without materials;
  3. Along with signatures, it was mortgage which verified the deal, and which can be put into business development and personal needs by a producer.

And who will be with greater incomes? Fall will show – when the deal must be fulfilled. Yes, it may seem that market price for the item of trading will significantly fall. Examining futures, examples of such consequences can be looked for in the recent past: oil and its derivatives, as the natural gas, were being traded in 2014 at the price by far lower than of futures made in the beginning of the year. The difference was 30-40%, i.e. making deals in real time, a customer could save millions. But in order to realize the essence of this mechanism, you should imagine the opposite situation. As for an example, we’ll take the same, unstable 2014: coffee raised in price. Those who made a futures for supply of grains before flowering, gained 43% of profits in December. Purchase of futures insures both sides: producer – from an abrupt price fall or no demand; consumer – from lack of supply and price rise. If we speak about the issue what is futures trading simply, then it’s the mutual agreement of selling the concrete resource in the certain period of time with the price arranged before.

Futures’ Features and Main Rules of Deals

Main rules of confirming futures deals were developed in the 19th century. They have gotten few changes since then, and the contract description (“futures specification” in world economics terms) consists of:

  • The name of the basic asset – the item of trading;
  • Its price, with which the deal will be fulfilled in spite of all manipulations with a futures and market price by the moment of fulfillment of the deal;
  • Amount of resource which will be equalized with the concrete block;
  • Deadlines of agreement terms fulfillment and mutual transactions of sold futures;
  • The type of a futures (cash-settlement or physical delivery).

In modern economics, when the most part of operations is being made through the exchange, features of the most demanded futures are set by these financial institutes, while ordinary participants of deals operate with ready stakes. Enhancement of exchanges’ role spawned another form of working with futures: standard stakes began being resold by both sides. A producer, who is not ready to fulfill terms of the contract, can yield a part of obligations in an analogical company’s behalf, and so does a consumer, who changed mind and decided the deal wasn’t profitable for them. The exchange anyway controls fulfillment of futures terms. In the arranged deadline, both sides will meet contract conditions: if we speak about modern e-trading, then after 24 hours since the order is closed, the system will calculate profits and losses for participants.Futures codes

Futures Definition and a Short Insight: Main Terms of the Market

For a reader who thinks seriously about working and making money at the futures market, it’s not likely to be enough just to give a little review of the problem what is futures trading simply. The reader will swiftly move to more serious literature. It order to easily understand what gurus of exchange trading talk about at seminars, you should know several main terms: what are futures and options, what is futures expiration and so on. I won’t overload you with difficulties and I will explain terms simply:

  1. Futures (definition) is the agreement about future deal with arranged price and time of fulfillment.
  2. Futures trading is purchase and sale of these tools.
  3. Circulation time is the period from making the deal to its fulfillment, trading time.
  4. Futures order book is the selection of neighboring positions of supply and demand.
  5. Futures price is the current cost of a futures.
  6. Physical, real or market price is the cost of the commodity at present.
  7. Basis is the difference between futures and market price – can be either positive or negative.
  8. Step is the minimal price fluctuation.
  9. Expiration date is the time of closing the deal, purchase of the commodity by the owner of a futures.
  10. Contango is the situation when futures price is higher than price of physical market.
  11. Backwardation is the situation when futures price is lower than price of physical market.
  12. Variance margin is the profit or loss from the deal.

 

Cash-Settlement and Physical Delivery Futures – Contracts with Different Features of Fulfillment

Realization of the issue “what is futures trading simply and how to make money with them” is impossible without recognizing the difference between two main types of contracts.

Physical Delivery Futures are contracts of purchase and sale with suspended execution and fixed price. Sides of the deal, which must be at least two, arrange the delivery from the one and for purchase from the other. In the agreed time, assets are transferred with the price fixed in the contract. The purchase is guaranteed by the mortgage or frozen amount at accounts of traders.

Cash-Settlement Futures (examples will be discussed further) doesn’t stand for the exchange of commodities between sides of the deal. This is just a financial insurance (hedging) risks. Trading at the exchange goes, commodities are being purchased and sold, and participants of cash-settlement futures trading provide contracts fulfillment by their money. That who bought a futures with the price lower than market by the time of expiration, will get their profit. And that who didn’t guess jumps of price and got cash-settlement futures (definition above) with the price higher than market by the time of expiration, covers the difference with their deposit.Types of futures

We have already figured out what futures expiration is. As this form of deals is more widespread in the century of Internet, I will give you one more answer to the question “what is futures trading simply”, using the futures example related to coffee grains, because a cup of this drink is now on my table:

  1. Price for American grain is more than $1.35/lb at the market in this moment, according to the futures contract.
  2. Price movement may be significantly affected only by the weather forecast for the Brazilian summer, as the volume of harvest directly depends on the ratio between sunny and rainy days;
  3. From calculation of futures prices for coffee, we can sort out demand, as this “drug” is good all seasons and always demanded (believe me);
  4. Having examined the chart of price growth (it rose from $0.7 for the last month) and realized that current $1.35 is too great jump, I would stay aside from purchasing a futures for coffee with this price. It must be that the deal will close at $1.2-3 in September, i.e. I would lose at purchase and amount frozen by the exchange was debited from the account.
  5. But for the purity of the experiment, let’s imagine the opposite situation: I buy a futures now, and tomorrow they say that the cataclysm has swept the half of Brazilian plantations, and coffee price flies up. In several days, I will be able to resell my contract, gaining money from speculation, as futures price will be by far higher. Actually, as a patient man, I wouldn’t do that: by fall, due to higher demand for coffee In cold seasons, coffee price always rises, and I will get maximum profit in very last months of trading.

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Modern Exchanges or How to Sell Weather Futures – Examples

As the goal of out talk is to figure out the answer to the problem “what is futures trading simply”, I gave the matching example, which stands in front of me. If we examine this problem broader, modern futures exchanges trade with everything that can be somehow realized. Originally, trading was hold only for the most demanded commodities, imported and exported worldwide, and the process of obtaining futures reminded the game where the winner is that who yells louder. Trading in the 21th century seriously differ, but for that, a range of adjustments were to be implemented into the system:

  1. Broadening the list of basic assets;
  2. Systematizing their markup;
  3. Creating online system of trading.

The online trading platform Globex was tested at the Chicago Commodity Exchange. And platforms that were created similarly to that one today let traders see the futures market and trading for materials on their monitors, participate in the process online, without yelling at the trading hall.

I don’t want to bother my reader with plenty of useless encyclopedic statistics. So, here is the summary:

  1. There are more than 10 major exchanges, holding operations with the significant list of futures assets;
  2. Thousands of analysts and auditors work at each of them;
  3. 5 days a week, more than 160 groups of commodities are being sold and purchased every second;
  4. Agricultural commodities are being actively traded, along with metals, currency, shares, raw materials and energy carriers, interest rates and stock indices.

Futures marketI must mention “exotics”: in 1997, at that Chicago Exchange, and then at several others, there emerged an opportunity to trade weather. Weather futures appeared as this factor always leads to changes of almost all the quotes: exchange traders, who are players to some extent, couldn’t miss the chance to forecast this aspect. For 0, average weather conditions were take, which are implemented into calculators of electrical energy consumption. Positive and negative forecasts for the ratio to the real situation are the same item of trading, as the cattle or fuel oil, and weather futures are continually demanded.

Figuring out Futures Ticker: Marking Formation from A to Z

Online deals are made within a split second, and traders from the whole world take part in trading. This speed of working is provided by the general system of futures marking. It’s quite simple, though, it looks difficult for a non-experienced person. Realizing the answer to the question “what is futures trading simply” and recognizing features of futures description, you will easily figure out all the nuances of this process.

Marking consists of 3 main indicators:

  1. Tool – the base of the contract (2 symbols);
  2. Month of expiration (1 symbol);
  3. Year of fulfillment (1 symbol).

You will just need to remember month-marking: from January to December, it will be like F, G, H, J, K, L, M, N, Q, U, V, X, Z.

In practice, it will be simpler to get on with marking. Let’s take a mysterious item of trading “GzZ7”:

  1. Gz – Gazprom’s stocks;
  2. Z – December;
  3. 7 – 2017.

So this is the futures for Gazprom’s stocks, expiring in December 2017.

Analogically:

  • SlV6 – futures for silver with the date of fulfillment in October 2016;
  • EuK6 – futures for EUR/RUB rate, which expires in May of the current year.

Having learned marks of popular or more preferable assets, you will be able to orientate swiftly in demand and supply, selecting needed abbreviations mechanically.

How to Make Money with Futures

It's not likely that readers came to this page because of curiosity and wish to know anything. I am sure the main point is to answer the question “what is futures trading” and to figure out how to make incomes from them. Further, we'll look into ways of making profits with futures and how to choose your personal method.

Let's look into details of exchange operations with futures:

  • speculative
  • arbitral
  • hedging risks.

Futures are the universal tool. It provides a trader with plenty of opportunities from direct earning with supply and changes of the base (i.e. difference between futures price and real price) to complicated speculative schemes which are the top of exchange trading.

Futures as Insurance from Price Rise or Fall: A Tool for Sharks of Macroeconomics

The desire to hedge (insure) risks caused appearance of futures. But if we speak about the present, orders related to compulsory in-time supply make less than 3% of all orders. The rest are calculation speculative operations. Nevertheless, this type of orders exists: suppliers look for guaranteed demand for their production; customers look for profitable offers. Mostly, participants of these operations are the first and the last unit of futures chain: sooner or later, the contract will come to the end customer. Unfortunately, it's quite difficult to enter this segment of business, surely if you don't need several ten tons of wheat or if you don't need to sell several thousand acres of wood area.

For example, Russian companies are participants of futures markets. With that, Gazprom's sold futures let the company stay float in the moment of abrupt fall of price for energy carriers the last year: futures contracts provided by far higher oil price. Also, futures market equalizes prices and makes jumps caused by speculations not so noticeable.Trading operations

Speculative Operations with Futures: Money from Nothing and Skills to Cope with a Situation

The range of advantages of popular futures made this market attractive for those who gain profits only from reselling, and who never touched money they operate with, goods they always “purchase” or “sell”. Futures for dummies is the convenient tool. Working with them minimizes risks and creates relatively safe conditions of trading. Time of trading with the concrete futures can be a day and can be several months – and price for this period fluctuates significantly due to approachable and forecastable reasons. This gives the opportunity to calculate rises and falls, making money with the difference. Realizing what futures trading is and being able to analyze the impact of an event on prices, you can make forecasts mostly without any mistakes. Advantages are obvious – they let you make choice in behalf of futures market, even if operations at forex or stock trading are on the other hand:

  • more predictable price jumps;
  • high profitability due to high leverage (amount mortgaged offered by a broker);
  • good liquidity;
  • minimal time of holding positions open;
  • fair fees.

Experienced traders successfully work in this field of activity, increasing deposits from relatively moderate amounts because of their knowledge and analytical mind.

Arbitral Operations with Futures: Multiway Interexchange Deals

Arbitral operations are featured by complex mechanics: during trading, a trader has several orders opened at the same time, which are made in different time at the one exchange, or at the same time but at different exchanges. The goal of all maneuvers is to gain profits from the same tool for the difference between futures’ and stock price (intercommodity arbitrage), futures with different expiration time (calendar arbitrage) and so on.

A “prong” can emerge is participants of trading at two different exchanges conflict at opinions about the rate, and price of the same commodity starts to differ significantly. This situation can’t hold for long, and the rate will be leveled soon – this what a trader must orientate on.

To explain it simpler, let’s take at least one situation (I remind that there can be plenty of them and arbitral operations require serious theoretical preparations and practical experience of trading, let alone the initial deposit). But, coming back to the example of spatial arbitrage:

  • two exchanges: FORTS and MIFUT trade futures at shares of Gazprom (let’s take the instance of Russian oil and gas producer);
  • Having gotten the “prone” between two platforms, sell the expensive and at once buy a cheap futures with the same expiration date;
  • Inevitable aligning will let you gain profits – not very high but guaranteed.

Profitability of arbitral operations is provided by the continuous market control, technical analysis, great number of orders for a short time and full diving into the situation. For acquaintance with financial market and beginning, arbitral operations is not the best choice. Comparing multiway algorithms with, for example, binary options, which give profits just for correctly forecasted course, the result won’t be in behalf of the former.

Futures minimize risks, but binary options show good profitability. Having figured out in details, what futures and options are, you will realize the essence of the choice: slow and safe income or some risk and profits in exponential growth. Risk, by the way, is compensated by knowledge and clear mind.

Futures and Options – What to Choose?

A novice in exchange trading, who is just looking into opportunities of making money for themselves, can be frightened by futures and lots of information related to this market. Even realizing the answer to the problem what is futures trading simply, it’s difficult to get ready for the first deals. Nevertheless, I must remind you that futures for dummies is one of the most secure tools.

On the Internet, there is much information about techniques of working with them and cleanness of statistics of prices for some commodity: coffee, oil, gas, share of companies. The genuine desire to become a real expert will let you master all that stuff and call yourself successful. In your character and mind or humble initial capital require more active actions, I advise you to examine the opportunity of working with binary options: technique letting make up to 80% profits with each deal of several minutes long.

The base of success in this case lies in proper following trading strategies and money-management. You should select a reliable broker, by the way, which will let you not only make but also withdraw everything you earn. Probably, binary options will become a chance to gain your starting amount for operations with futures, and probably, the business of life.

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Technical Summary

Timeframe 2018-01-22 14:01:35 GMT
EUR/USD
1.2253 +0.0030 (+0.25%)
Summary Strong Buy
Moving Averages: Buy (12) Sell (0)
Indicators: Buy (7) Sell (1)
EUR/USD 1.2253 Strong Buy
EUR/RUB 69.2850 Strong Buy
USD/RUB 56.5511 Strong Sell
GBP/USD 1.3929 Strong Buy
USD/JPY 110.72 Strong Sell
EUR/JPY 135.67 Strong Sell
AUD/USD 0.8020 Neutral
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