If you want to make money off of trading, then futures trading might be just the thing for you. You don’t have to be a prophet to understand how to make money off of futures. However, in a certain sense you do have to learn how to predict the future. So what are futures, and how do you trade them? Read on to learn more.
Futures are contracts that obligate a buyer and seller to buy and sell a specified commodity in a specified amount at specified date in the future. That’s a lot of specifics, to be sure. So why would anyone enter into an agreement to buy or sell a product in the future, instead of just buying it now?
Why buyers and sellers use futures
Futures allow buyers and sellers to inject speculation into markets, which in turn creates risks. And where there are risks, there is also a potential for rewards. Further, sellers often need money sooner rather than later. For example, a farmer growing soybeans might need more money to upgrade equipment, buy seeds, and other things. His soybeans, however, might not be ready for harvest for another month.
By using the futures market, the soybean trader can sell his soybeans now. He will receive money in the short-term and when the soybeans are harvested, they will be delivered to the buyer. This way, the buyer also has his delivery of soybeans guaranteed.
So why would a buyer buy soybeans through a future instead of just buying soybeans right now? After all, some seller somewhere must have soybeans to sell. For one, the buyer might believe that prices are low right now, but that they will rise in the future. She or he may be able to secure soybeans to be harvested in the future at cheap prices now, and if his or her intuition turns out to be correct and prices rise, profits will be made.
Also, some products really do sell out months in advance. If a buyer wants to secure a supply of oil, for example, so that it can be refined into plastic, he may need to buy it months in advance. Futures allow the buyer to secure vital supplies of resources that will then be delivered at a future date.
Investors and futures
Traders often invest in futures not because they want soybeans or oil or any other type of commodity. Investors usually don’t take delivery of the good, but instead sell the contract to someone else who is actually looking to take delivery. So why do investors get involved in futures markets if they don’t want to actually buy the goods?
As we pointed out earlier, futures inject speculation and allow people to predict whether or not prices will rise or fall in the future. Investors are interested in these rising and falling prices. If an investor predicts a trend in prices right, he or she could end up making a lot of money!
If an investor buys a future for 10,000 barrels of oil at $80 dollars per barrel with a six month delivery, and six months from now oil prices have skyrocketed to $160 dollars per barrel, he or she will make a ton of money. Why? Oil selling in the market will cost $160 dollars, but the investor will have paid only $80 bucks per barrel!
Many investors prefer futures because they are more comfortable predicting market trends and supply and demand for commodities than they are for predicting the success of individual companies or the rise and fall of stock markets. While the decision of what to trade and invest in is ultimately up to you, futures are definitely worth a look. So make sure you consider futures trading if you are looking to invest!