Futures Trading 
An Introduction To The World Of Future Trading
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Futures Trading  - How The Futures Market Works

OK - let's start to look at how the futures markets actually work, and I hope that in the last two pages I have managed to get across to you the fact that futures trading is very different from any other market that you may have traded in the past. Whilst many of the instruments are financially based such as bonds and currency, many are not, and the approach and research you need to do is almost the same as if you were a wholesaler in the physical market. So if you were in wholesale food production, you would regularly check on livestock prices, worry about availability ( supply and demand), consider the long term trends, the effects of viral infections such as foot and mouth, read the trade press etc. In other words you would become an expert in your field.

Futures Trading - The Exchange

The central player in any future market is of course the futures exchange where futures contracts are bought and sold. Trading takes place against a background of regulatory surveillance, not only by the exchange itself but also from other regulatory bodies. In the US this is the CFTC, the Commodity and Futures Trading Commission. Now there are many exchanges throughout the world, but I have listed the principle ones below which I hope will help you to get started:

Country/region Exchange Details
Europe NYSE Euronext
United Kingdom London Metal Exchange
United States Chicago Board Options Exchange
United States Chicago Mercantile Exchange
United States Chicago Board of Trade
Unted States New York Mercantile Exchange
Hong Kong Hong Kong Futures Exchange
Japan Tokyo Commodities Exchange
Australia Australian Securities Exchange

Each exchange has its own list of products that it trades, and each product is traded in a designated futures trading pit using open outcry, which again is an oddity of the futures market. Whilst almost all other markets have moved to wholly electronic trading, around 30% of futures trading is still conducted using the open outcry system. Each trading pit is divided into a number of sections designated for trading in particular contract months and markets. No trading can take place outside a contract's assigned pit, nor is trading permitted at any time other than during those hours which have been designated by the exchange. Traders stand in a tiered trading pit, shouting and signalling bids and offers with their hands. Different classes of traders are identified by their coloured jackets, and if you ever get the chance to go and  watch the floor in action, I would urge you to go - it is very exciting and very noisy! Floor traders prefer it, as they say it gives them opportunity to see the "whites of the eyes" and judge the levels of fear and greed in the market - something you can never see using an electronic system.

Now, in addition to providing the market place that allows us to trade futures, the exchanges also design and specifies the contracts it wishes to offer on the exchange. One of the questions I am often asked is who actually determines the specification? The answer of course is the exchange - it is in their interest to ensure that the contracts they offer will be interesting to both buyers and sellers so that they become a widely traded product. The underlying specification is normally drawn up by the exchange following consultation with traders, and fund managers.

Futures Trading - The Futures Broker

When I first started trading in index futures, in order to confirm a price I first had to call the broker, who would then call the trading floor for a price, and then confirm the price back to me on the phone!- fortunately things have moved on since then. Now the term futures broker generally refers to an exchange member who executes orders for the accounts of one or more of the clearing members and their customers. A local or floor trader is a member who executes trades for his or her own account, of for a clearing firm. Each will wear a different coloured jacket and carry a three letter badge to identify the broker or trader clearly. Price changes are relayed electronically to the huge display boards above the exchange floor for worldwide transmission.

Futures Trading - Electronic Trading

In addition to the open outcry system outlined above, buyers and sellers of futures contracts also come together through electronic trade matching, which now forms the bulk of futures trading, at around 70%. Most exchanges around the world operate a dual system of electronic and open outcry. Some products trade simultaneously on both, and others such as e-mini stock index futures only trade electronically ( these were the ones I used to have to ring to get a price) - it was exciting as you could hear the open squawk box onto the floor of the exchange, but nerve wracking as the price on the screen had invariably changed by the time I got my order filled. Currency futures are one of the few contracts that can be traded virtually 24 hours a day.

For most of you, I suspect you will trade electronically on line, and never come across the pit trading, but I wanted you to understand how different this market is, and how the trading methods still linger on, rooted in the history of the exchange and the real products that they trade.

OK - now that we understand a little of the mechanics of futures trading and of how the market works, let's take a closer look at the market players, and how and why the futures contracts fluctuate in price on a second by second basis.


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