Futures Trading 
An Introduction To The World Of Future Trading
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Futures Trading  - The Market Players

OK - on the previous page we looked at the mechanics of the futures exchanges and how trades are managed both by floor traders and electronically, but who are you trading against in your futures trading? Let's take a look at the two principle types of player, and don't forget one of these will always be sitting opposite you on the other side of your contract.

Futures Trading - Hedger or Speculator

When you trade in the futures market, there are essentially only two types of market players, the hedger or the speculator. The hedger is looking to hedge future risk, whilst the speculator is purely looking to make money by forecasting the correct movement of price. Let's look at in the table below:

  Reasons for buying futures contracts Reasons for selling futures contracts
Hedger To lock in a price in order to provide protection against future price increases To lock in a price to provide protection against future declining prices
Speculator To profit from future rising prices To profit from future falling prices

The details of hedging can be a little complex, but the principle is very simple. Hedgers are both companies and individuals that buy and sell futures contracts in order to establish fixed prices in the future, for something that they later plan to buy or sell in the cash ( or real ) market, i.e. for real cash. The number and variety of hedges are almost limitless. A cattle breeder can hedge against a decline in livestock prices, whilst the supermarket or meat packer can hedge against increases in prices. Borrowers can hedge against higher interest rates, and lenders against lower interest rates. Investors can hedge against declining stock prices - I'm sure you get the picture by now. This is a very different market from that of the traditional stock exchange, where many traders and speculators begin their trading and investing lives. In buying and selling stocks or shares, you are trading in the real 'cash' market, where a small part of the company changes hands each time they are bought and sold. In addition the markets are controlled  by market makers, who manipulate prices on an hourly and daily basis in order to take advantage of any news to create demand, or panic buyers into selling and visa versa.

Ironically, the futures markets whilst not being  'cash' markets, are actually much closer to being a true representation of what is a fair market, than the stock markets will ever be. We will look at this shortly in 'Price Discovery' on the next page. So in trading the futures market we are looking at something which is real, in the sense that real products or services are hedged by real people in the real world of business.

Now before you think ' Oh I will never be a hedger as I am an individual trader' - think again - as a currency trader I sometimes use the futures market to hedge positions in my spot market trading - so don't think just because you are not a multinational company that you won't ever use a futures contract to hedge - think again.

Now obviously where there is money to be made there is speculation, and for those of you reading this, 99.9% of you will be speculators, like myself, for most of the time. Now we will look at the risks and opportunities of the futures market a little later, but for now all we need to know is that if we think a contract is going to increase in price we buy, i.e. go long, and if we think it is going to fall in price we sell i.e. go short. Our contract will then find a buyer or seller who will take the opposite view. This could be another speculator with a different view, or alternatively a hedger who is looking to hedge future risk.  Now remember as a speculator we do not want to have to take delivery of the physical goods so manage your trades with care, and in case you are wondering, yes you would have to deliver if you went short and forgot to close out your position!!

OK - those are the market players which I hope has given you a flavour of why I prefer this market to many others. Now let's look at how contracts are identified, so that you know what you are buying and selling in your futures trading, and to do this I have used the Chicago Mercantile Exchange as a model, as it one that I know quite well, but don't worry the others are very similar.

 

 Futures trading -  next page


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