Futures trading deals with trading Futures Contracts. What precisely is a Futures Contract. How does one trade it? A Futures Contract, also known as a cash forward sale or a “Forward” Contract, is a contract between a buyer hooked on a specific product, and a seller engaged in supplying the same product for a specific future date. Futures Contracts are formal agreements, meaning that they obligate both the buyer and seller; neither can default. Futures Trading is defined as a zero sum game. What that means is that every dollar made by the buyer is a dollar lost to the seller and vice versa. When prices are too high or too low, then it is the buyer or the seller that profits, but they profit at the expense of the other. Let’s see an example. Say pork belly prices rise, the farmer benefits but the bacon manufacturer suffers. If pork belly prices fall, the farmer suffers, but the bacon manufacturer’s bottom line improves.
Futures trading takes place in two ways. First, commodities are traded on the floor of a Futures exchange, such as the Chicago Mercantile Exchange (CME). There trading takes place in an open outcry pit. But Futures trading can also take place “electronically,” over the internet, where individual traders put in their buy/sell orders from their desktop trading platforms.
Futures traders can be broken into 2 groups, hedgers and speculators. An example of a hedger would be a farmer, manufacturer, exporter or importer. The goal of the hedger is to create futures positions that reduce the risk that the price of their commodity may fall. For example, a pork belly farmer believes that his pigs will be grown by August. He signs a pork belly futures contract before the slaughter at the current price in May for delivery in September. In May, the price of pork bellies is high because of reduced supply. Should the price of pork bellies drop by September (when the contract expires), the farmers’ price has already been ensured. Mind you, the farmer is assuming a risk. What if there is a virus and many pigs die before September. The price of pork bellies would rise even further, but the farmer is already obligated to deliver pork bellies at the price negotiated in May. The farmer would lose additional profit. Conversely, in September there might also be a huge number of pigs and the price of pork bellies ends up being lower than his May price. In this case he wins.
Speculators, on the other hand, are trading Futures for the sole purpose of earning a profit, not for protecting the price of their crop. Speculators actually comprise the majority of traders in most markets. Speculators are willing to assume risk in the hope that if they buy low, they can sell high (going long), or by selling high, they can later buying back low (going short). For example say the soy speculator knows that the weather has been a problem for months and the soy crop will be limited in September. The speculator is happy to buy the soy Futures contracts in July at the current price. He is betting that the price of soy will skyrocket and he will make a killing in September after the small harvests in August. Speculators provide the liquidity needed to fuel the Futures market. Without speculators, no one would take the other side of the hedgers contract. As in the example above, the farmer sells the soy to the speculator in July for the current price. The speculator assumes risk, hoping that by September, the delivery date, the price of soy has risen and he can make a profit at the farmer’s expense. What he prays doesn’t happen is that come September, the price of soy goes down, meaning that he over paid.
Prior to organized Futures exchanges, like the Chicago Mercantile Exchange (CME), Futures trading was a far more risky proposition. Contracts were drafted between one farmer and one speculator, and signed wherever the farmer happened to be selling his produce, for example, in farmers markets. There were a lot of problems with these personal contracts. First and foremost, either the farmer or the speculator was allowed to default on the contract. Who would enforce payment or delivery? If the speculator was going to lose his shirt, he would not complete his side of the contract. If the farmer realized that the price of pork bellies had risen dramatically, he would default and sell the pork bellies in the open market. Since these contracts were drafted between 2 parties, the speculator could not sell his contract to another speculator. Here’s another problem…there was no one who would certify the quality of the delivery. Farmers could fill their side of the contract with lower grade pork bellies, and the speculator could not do much about it.
Since the start of organized exchanges, it became the job of the exchange to validate quality, payment and delivery. Exchanges regulated that now good-faith money was required with a third party to make sure of contract performance. This reduces the number of contract defaults. Exchanges were finally able to standardize contracts, stipulating the terms of each contract, like commodity delivery dates and product grades.
With the coming of organized exchanges, Futures trading has now gone far beyond just buying and selling of commodity contracts like wheat, rice, corn, and soy. Today, there are futures contracts available for many asset classes, including treasuries, energies, equities, and currencies. Futures are an asset class called “derivatives.” A derivative is a security whose price is derived from one or more underlying assets. For example, the S&P 500 Futures Contract has as its underlying asset — the New York Stock Exchange’s (NYSE) S&P 500 Index. The S&P 500 Index is one of the most actively monitored equity indexes worldwide. The index is comprised of the top 500 well recognized stocks traded on the NYSE. Here’s the problem with the S&P index, however…you cannot trade the Index. The CME created the S&P 500 Futures Contract that you can trade. And in the case of the S&P 500 Futures Contract, when the value of the S&P 500 Index appreciates, the S&P 500 Futures Contract appreciates with it and vice versa.
Now, Futures can also have a currency index as its underlying asset. For individual investors, the Currency Futures Market is designed for the small number of contracts that individual investors intend to trade. With Currency Futures, individual investors can trade the exact same currencies that are being traded in the Forex market, but trade on the CME.
Shadowtraders specializes in training individual investors in Trading Futures. Most other Futures education companies are limited to training only the S&P 500 Futures Contract, and specifically the Emini, earmarked to individual traders. Shadowtraders is far more interested in introducing its clients to a variety of different Futures, including energies, currencies, treasuries, etc. We trade assets with liquidity and volatility. We know the days of the week that a particular Futures contract trades, the times of day it trades best, how many contracts are traded for that, whether or not you can it at all, etc. That is Shadowtraders specialty.
If you are experiencing losses trading the S&P 500 Emini, or if you are new to the Futures trading game and want to get more information, attend the Shadowtraders Webinar held on Monday nights.
Barbara Cohen has been a professional day trader for over 10 years and is the CIO of Shadowtraders. She has trained hundreds of students to trade the Futures Market with Shadowtraders trading seminar. Before you purchase any trading seminar, make sure you attend Shadowtraders Monday Night Webinar, and hosted by Barbara Cohen
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