Futures Market

The futures market, occasionally referred to as a futures exchange or derivatives trading exchange, is a trading platform in which brokers and third-party traders exchange futures contracts – legal or financial agreements that are tied to commodities that are trader at a future point. One of the most well-known forms of short- and long-term investment, futures markets operate around the world.

Despite this, they’re also one of the least widely understood forms of trading, largely due to the non-instant basis of most futures contracts. While stock in public companies – or private stock sold over a secondary exchange – is traded in real time, with ownership changing at the point of trade, futures contracts are tied to exchanges likely to take place in the future, adding an additional trade layer.

For this reason, futures contracts are often avoided by relatively new investors, instead falling into the hands of more experienced traders and investment contracts brokers. In this brief guide, we will look at some of the more common forms of futures contract, the way in which the futures markets of the world operate, and how futures contracts have been traded over the past few centuries.

Futures contracts have been traded for hundreds, if not thousands, of years, albeit in a form fairly different to the one most of us understand today. A textbook example of futures trading – literally one of the most frequent textbook examples – is of Thales, a Greek strategist from what is known now as Turkey, who hedged the potential risk of poor olive harvest yields to control demand.

Thales, in the months preceding the olive harvest season in Ancient Greece, predicted that the year’s harvest would outweigh all others in size and scale. In keeping with his prediction, he approved the region’s farmers, offering a contract to them for exclusive use of their olive presses and total access to their harvests for the season. Not knowing how the harvest would perform, most of them agreed.

Although a relatively basic example, this contract outlines the principle of futures markets fairly well. Thales’ purchase of exclusive rights to the olive presses allowed him to control demand at a future date, limiting the options of the farmers and granting significant advantage to Thales. It’s a simple version of futures trading, but one that’s certainly applicable to today’s futures markets.

Today, many of the top performing futures exchanges operate through a fairly basic principle of arbitrage – futures contracts are purchased at a certain rate, and resold when the market may see more value in them. This allows futures traders to act in a role similar to stock traders, capitalizing on the demand for any one contract as it grows in public awareness and demand in the open market.

Despite the olive pressing example, futures may be of almost any form – currencies, sales contracts, and other financial instruments are often the subject of a futures trade. Futures markets are made up of thousands of different contracts and underlying assets, many of which may appear to be of small demand to some; however, their value can grow significantly as the contract date draws nearer.

There’s an inherent risk in futures trading; one that many of the more financial savvy readers may have picked up on. It’s the risk of default by one party or another on the futures contract – a fairly common possibility in which one party fails to carry out the agreed-upon deal. To protect against this type of activity, many futures markets require traders to work with an extra clearings house.

The clearings house acts as an escrow service for buyers and sellers, offering security to both of the parties involved in any trade in the event of an unplanned non-sale or non-purchase. Traders need to post a ‘margin bond’ – typically 5-10 percent of the value of each trader – with this clearing house in order to secure the contract and minimize the possibility of a non-purchase or sale default occurring.

Futures contracts, despite being trader informally for hundreds – possibly thousands – of year, have only gained a public trading point in the last four decades. The Chicago Mercantile Exchange was a leading party in establishing futures trading alongside commodities and public company stock, and soon saw the practice of futures trading grow into a significant portion of the global finance market.

Similarly, futures trading exchanges popped up in leading financial areas such as London and New York City over the following decade. Many of these have since been conglomerated into exchanges and other financial centers, with trades occurring in a single space. Many others have merged with a stock or commodities exchange within their city, as is often the case in smaller financial markets.

While futures trading may seem somewhat more complex than its alternatives in commodities and stock trading, it’s actually a relatively simple practice with the right outlook. As with all investment forms and options, it’s essential to gain an understanding of the market before you participate. For a bright career in the futures markets, a little research and study can certainly go a very long way.

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