What Is Futures Trading
Background of Futures Trading
For many years futures trading has been considered either too risky or too sophisticated for the average investor. Most myths are born of ignorance, and the futures myth is no exception. For all too long, futures trading was either ignored or shunned in economics texts and, as a consequence, the general public was not educated in the basics of futures. No informed choice could, therefore, be made. Investments in securities, stocks, bonds and even stock options, however, received considerable attention. It is generally believed that trading in stocks has more historical justification and, therefore, more value in an economic education.
There are, in addition, a number of other reasons for the historically diminutive role of futures trading, few of which are valid. Generally, objections to futures trading are based on either partial or distorted facts. So, before launching into an explanation of precisely what futures trading is, it may be necessary to clear the decks of any misconceptions you may hold. First, let’s examine some of the standard objections to futures trading, so that we may have a relatively clean slate upon which to write the new learning.
Let’s take a look at a few of these misconceptions.
1. “You Can Lose All You’ve Invested, or More, if You Trade in Futures.”
This is true. However, the key word is invested. Trading futures should in no way, shape or form be considered an investment. As a speculation, however, the rules of the game become distinctly different — high risk is necessary for high reward. Nevertheless, even ‘high risk’ does not mean that the common sense rules of good trading and money management (to be taught in this course) should be ignored. It has been demonstrated clearly that a balanced investment portfolio consisting both of stocks and futures performs better, on average, than a portfolio consisting exclusively of stocks.
2. “Trading in Futures is a Gamble.”
This is another misconception. In fact, trading in futures is, technically and fundamentally, no different from trading in stocks. The odds of being right or wrong are essentially similar. However, due to lower margins, the odds of making money in futures are probably lower than those of making money in stocks. © 2000 MBH Commodity Advisors, Inc. C1L1-4 Ultimately, though, the possible percentage return in futures trading is considerably greater than the potential return in stocks. Futures trading is, therefore, no more of a gamble than trading in stocks. Carefully and closely following the rules of successful futures trading will help reduce the risk and gamble.
3. “Futures Trading is for Insiders. It’s a Rigged Game.” (Markets are Manipulated.)
These two misconceptions go hand in hand There is probably less inside information available in futures than there is in the stock market. The United States Department of Agriculture, the Commodity Futures Trading Commission and the National Futures Association have all imposed very stringent limits on the total number of positions a trader may hold. They monitor the brokerage industry and large trader transactions very closely.
Important government information is guarded and kept strictly secret until the scheduled release date and time. In this way, the markets can function freely and with minimal effects of insider information. In fact, most markets cannot be manipulated for other than perhaps very brief periods of time. This is because they are too complex and diverse for any one individual or group to affect prices over the long run. Unavoidably, some traders will always have an edge based on inside information, but success in the futures market is very possible without access to such information.
Futures Trading, U.S., Composition by Type of Futures Contract, 1970 to 2004 (Photo credit: Wikipedia)
4. “Trading in Futures Serves No Economic Purpose. It’s a Gamble, Pure Speculation.”
This popular misconception couldn’t be farther from the truth. The futures markets serve to stabilize prices. In fact, we often forget that futures markets in the U.S. were originally created to protect the farmer from volatile price moves. In today’s markets this same price protection is needed by farmers, food companies, banks and many other large institutions, often referred to as ‘hedgers.’ The speculators provide liquidity and are often willing to take market positions when prices are fluctuating significantly due to news, weather, crop conditions, etc.
This stabilizes prices by providing additional buyers and sellers to buffer extreme moves. Were it not for the speculator, prices would move more viciously, and the hedgers could not enter and exit the market as efficiently. And, were it not for speculators buying and selling regardless of price levels, the markets would be subject to great volatility. Supplies would stand a good chance of being disrupted and unstable. One probable reason for the Soviet Union’s demise was its lack of a delivery and exchange system for its commodities. A functional futures market would have contributed considerable stability to its economic system while also reducing producer and consumer dissatisfaction.
5. “Futures Trading is Only for the Short Term.”
This is also incorrect. Futures trading can be either long term, intermediate term, and/or short term depending upon the orientation of the trader. © 2000 MBH Commodity Advisors, Inc. C1L1-5 In fact, some of the most successful futures traders — referred to as ‘position traders’ hold their positions for an intermediate- to long-term period of time. The particular time horizon or time frame that a trader adopts is an individual choice, which does not necessarily have to be short term to be prosperous. Many other misconceptions and misunderstandings plague futures trading — all bred out of either partial information or ignorance. One-by-one, these myths will be unveiled and corrected as your understanding of futures markets and futures trading increases. Now that a few of the major myths have been revealed, we can move on to the basics of futures trading.
To view the hidden content please Like this post on Facebook!