What is a futures contract?
Finance futures, also colloquially known as futures or futures contract, are probably one of the most basic, yet rewarding approaches to successful investing.
The idea behind a futures contract is simple: Help protect producers and suppliers from price changes.
When two parties go into business, financial security is probably on the top of their priorities. Unfortunately, the variation in the prices of goods based on supply and demand is inevitable. This is where a futures contract comes in handy.
How do finance futures work?
What a futures contract does to a two party contract is basically transfer the risk of price changes to a third party; the investor.
Let’s imagine there is a wood supplier that would like to sell a pre-determined amount of wood to a table manufacturer, at a fixed price and on fixed time intervals.
The two parties may agree on the current price but can’t by any means predict the future prices of either wood or tables.
In this case, to keep a constant income, both parties resort to an investor who is willing to take the risk of prices changing.
Consequently, when the supplier falls short on his wood supply and the prices go up, the investor gets to keep the profit. On the other hand, if it happens that the wood supply becomes exceptionally high and the prices go down, the supplier gets to sell at the same fixed price, while the investor pays the difference.
The same concept applies to the manufacturer but in reverse. If the price goes below the agreed-upon amount, the manufacturer still buys at a fixed price and the investor gets to keep the difference. If the opposite happens, the investor is obliged to pay the difference.
In other words, a futures investor essentially profits by speculating how the prices for certain commodities will move. The assets traded using futures contracts may include grain, gold, bonds, stocks, or even food products such as milk and beef. Having such a huge market for futures makes it essential for investors to take part.
The producers and the suppliers are also rewarded financial security. Unlike the stock market, the market for futures contracts is open virtually all week. This makes it more suitable for rather active investors, since prices often change very fast.
How big is the risk?
Both the supplier and the manufacturer maintain financial security to some extent. However, the investor is still not totally immune to the market price.
Futures contracts usually don’t “last” very long. The slightest change in market price affects the gains or losses significantly, especially when the agreed-upon amount of supply is huge.
Is it worth buying finance futures?
A futures contract might seem beneficial in the short term, and it is. However, there are considerations that need to be put in mind before approaching such investments:
- Futures require constant maintenance and careful predictions.
- Making huge earnings is just as easy as going bankrupt.
- Futures investment is more suitable for active investors.
- The prices change very fast and so do the corresponding gains or losses.
Nonetheless, a futures contract is an indispensible tool for investors who have an eye for price changes of certain goods, and are able to make accurate speculations on trends.