Futures trading is a popular way for traders to speculate on the price movements of various assets such as commodities, metals, currencies, and more. With the potential for fast profits, traders can employ different strategies based on their investment goals and market expectations.
Here’s a breakdown of how futures work and four common strategies used in futures trading.
Understanding Futures and Their Appeal
Futures are financial contracts that obligate the buyer to purchase a specific asset at a predetermined future date, while the seller agrees to deliver the asset at that time. These contracts are available for a wide range of assets, including commodities like oil, wheat, and metals, as well as currencies and indexes.
Traders entering into futures contracts are required to put up a margin, a percentage of the contract’s value, which serves as collateral. As the value of the contract fluctuates, both parties may need to add funds to meet margin requirements or close out the contract.
Traders often engage in speculative trading of futures, aiming to profit from price movements without actually taking possession of the underlying asset. The use of leverage in futures trading allows for amplified returns, but also carries increased risk.
Popular Strategies for Trading Futures
Here are four common strategies employed by futures traders:
1. Going Long Futures
Going long on futures involves betting on the price increase of the underlying asset by the contract’s expiration. This strategy mirrors buying call options and can result in profits if the asset’s price rises.
For instance, a trader anticipating a rise in crude oil prices could go long on oil futures, potentially earning a profit if the price of oil increases.
2. Going Short Futures
Conversely, going short on futures means betting on the price decrease of the asset. Similar to buying put options, this strategy can be profitable if the asset’s price falls.
For example, a trader expecting a decline in oil prices could go short on oil futures, aiming to profit from a decrease in price.
3. Setting Up an Intra-Market Calendar Spread
An intra-market calendar spread involves buying and selling contracts on the same asset with different expiration dates. This hedged strategy aims to capitalize on the price difference between near-term and longer-term contracts.
By setting up a calendar spread on oil futures, for instance, traders can benefit from changes in price differentials between contracts.
4. Setting Up a Commodity Pairs Trade
A commodity pairs trade involves trading contracts on two different commodities that share a historical pricing relationship. This strategy leverages the convergence or divergence of prices between the two commodities.
Traders can profit from a pairs trade by taking positions on commodities like gold and silver, anticipating a return to their historical price ratio.
Conclusion
While trading futures can be lucrative, it also carries significant risks, especially in volatile markets. Traders may opt for hedged strategies to mitigate risk while pursuing profitable opportunities in the futures market.
Editorial Disclaimer: Traders are advised to conduct thorough research and consider the risks involved before engaging in futures trading. Past performance is not indicative of future results in the financial markets.