How Does Futures Trading Work?

What are Futures?

A futures contract is a legally binding agreement between two traders to buy or sell an asset on a specific date at an agreed-upon price.

The most common type of futures contract is the futures contract which often tracks the value of other assets, such as stocks, commodities, and foreign currencies. Futures contracts are primarily traded on regulated futures exchanges.

What is Futures Trading

Futures trading is entering into futures contracts to buy or sell a commodity or financial instrument at some point. Futures trade on an exchange that allows buyers and sellers to enter these contracts.

 

There are two main types of futures trading:

  • Spot
  • Option

1. Spot Trading

It is trading on the spot market. In this type of trading, you purchase or sell a specific commodity or financial instrument at market price.

2. Option Trading

It is buying a call option and selling a put option. The difference between an option and a futures contract is that options are taken out months before the expiration date. In contrast, futures contracts are entered into months before the expiration date. Options are usually viewed as risks, while futures are viewed as investments.

Why Trade Futures?

Bybit offers bybit futures contracts to minimize the risk of purchasing an asset in the spot market. For example, a trader who wants to buy a particular stock may trade futures rather than buy it directly. While trading futures will not eliminate all risks for a trader, it does reduce them compared to purchasing the asset directly.

There are many reasons why traders choose to trade futures:

  • Investors may speculate on price movements. A trader who believes a stock will rise in value may buy a futures contract to own it when the investor feels more secure about the stock's price movement.
  • The longer the time horizon of trade, the more opportunity there is to increase gains from compounding interest. For example, if a trader buys an option with 30 days until expiration, options become more expensive over that period, which reduces the potential loss on such an option.
  • Many investors prefer a long-term investment due to the risk of volatility in the market. For example, if a trader believes a stock will rise in value, he may buy a futures contract and own it for several months or years.
  • You can view bybit futures contracts as hedging instruments for other investments. For example, if a large portion of your portfolio is invested in stocks or bonds, you may choose to trade futures contracts on those asset classes to offset some changes in the value of these assets.
  • Traders who wish to reduce interest rate risk may trade futures contracts. Interest rates typically rise and fall with increases and decreases in economic growth. Trading futures contracts can help reduce the risk of changes in an asset's value due to changes in interest rates since the future value is fixed by the initial price plus the interest rate index.
  • Types of Future Traders

There are two types of futures traders: hedgers and speculators.

1. Hedgers

These are individuals or corporations who extensively trade financial instruments to reduce risk. For example, a futures contract for Apple may be purchased by an electronics company so that it can lock in the price of its current inventory of Apple products. It allows the electronics company to purchase the parts and know its future costs.

2. Speculators

Use futures contracts to attempt to profit from changes in prices. While futures are a hedging instrument, they may be used by someone trying to make money from price moves. For example, if a trader believes an asset's value will fall, he will sell futures contracts and buy another asset such as stock, futures on another asset or put his money in the bank.

Types of Futures Contracts

There are three main types of futures contracts:

1. Commodity Future

Commonly known as commodities, futures, or futures. Futures are exchange-traded contracts. You can find many commodities on the commodity futures exchange. For example, corn is most commonly traded on the Chicago Mercantile Exchange

. Other futures markets exist for commodities such as wheat, cotton, coffee, oil, and cocoa.

2. Equity Future

It is a contract that trades in exchange for one of the assets listed in section 3 below. Equity futures include stock and index products such as stocks in the U.S. and other stock exchange markets, like the S&P 500.

3. Currency Future

One of six major currency pairs exists in the foreign exchange markets. The two currencies in each pair are known as the base and quote currency, respectively. Currency futures are agreements to buy and sell the base currency at a specific date in the future at a price agreed upon today. For example, a futures contract for the base currency USD/CHF is a contract to buy U.S. dollars on a specified future date at a set price

Desired Traits for Future Traders

Futures traders are exposed to risk. However, traders who have survived the volatility in the markets over long periods are those who choose long-term strategies and adhere to entry and exit points that maximize their risk while minimizing their reward.

1. Market Timing

It was once popular to trade futures daily. Doing so will lead to significant profits over short periods but will be a loss or only a slight gain over more extended periods. For example, if a trader buys and sells stocks daily, he will only earn additional profits from interest.

2. Risk Management

Some of the worst risks traders take include having insufficient money to trade or allowing losses to build up without knowing how large they are. Traders must plan their futures trading strategies accordingly and manage risk while trading.

3. Diversification

Futures traders must diversify their risk. It means not trading futures on one market or even multiple markets. You can trade a different futures contract every day and still diversify your share of risk by only trading one contract in each of the six major currency pairs.

4. Exchange Overall Liquidity

Traders should choose the exchange with the most significant overall liquidity. It will allow a trader to enter or exit a position without significantly affecting the price of their futures contract.

Trading futures can be risky. As with any investment, futures traders should first use a simulator that allows them to test various trading strategies and methodologies in a risk-free environment before trading real money.

Futures exchanges facilitate the trade of futures contracts by allowing two parties to agree to buy or sell an asset at a certain point in the future for an agreed-upon price. It is the sole purpose of a futures exchange. The result of agreeing to trade futures is that two parties have agreed to do something at a certain point in the future—a futures contract. 

 

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