Futures Markets as an Investment Tool

Futures markets are exchanges where futures contracts and options on futures contracts are traded. Exchanges may trade commodities, financial derivatives, or a combination of the two, as well as futures and options on indices and equity products. The major exchanges in the U.S. Are the New York Board Of Trade and its subsidiaries, the Coffee, Sugar, And Cocoa Exchange, Finex, New York Cotton Exchange and New York Futures Exchange; New York Mercantile Exchange; Chicago Board Of Trade; Chicago Mercantile Exchange; Kansas City Board Of Trade; and Minneapolis Grain Exchange. Additionally there are a multitude of international exchanges, including the foreign currency market, the FOREX. The U.S. futures market now includes Treasury bills and government guaranteed mortgages, or Ginnie Maes, thereby allowing speculation on changes in future interest rates.

How the Futures Markets Work

The futures market is a centralized marketplace for buyers and sellers from around the world who meet and enter into futures contracts. Pricing can be based on an open cry system, or bids and offers can be matched electronically. The futures contract will state the price that will be paid and the date of delivery. The profits and losses of a futures contract depend on the daily movements of the market for that contract and are calculated on a daily basis. Unlike the stock market, futures positions are settled on a daily basis, which means that gains and losses from a day's trading are deducted or credited to a person's account each day. In the stock market, the capital gains or losses from movements in price aren't realized until the investor decides to sell the stock or cover his or her short position.

Unlike traditional equity investors, futures investors are advised to only use funds that have been earmarked as pure “risk capital” - the risks really are that high. Once you've made the initial decision to enter the market, the next question should be “How?” Here are three different approaches to consider:

• Do It Yourself - As an investor, you can trade your own account without the aid or advice of a broker. This involves the most risk because you become responsible for managing funds, ordering trades, maintaining margins, acquiring research and coming up with your own analysis of how the market will move in relation to the commodity in which you've invested. It requires time and complete attention to the market.
• Open a Managed Account - Another way to participate in the market is by opening a managed account, similar to an equity account. Your broker would have the power to trade on your behalf, following conditions agreed upon when the account was opened. This method could lessen your financial risk because a professional would be making informed decisions on your behalf. However, you would still be responsible for any losses incurred as well as for margin calls. And you'd probably have to pay an extra management fee.
• Join a Commodity Pool - A third way to enter the market, and one that offers the smallest risk, is to join a commodity pool. Like a mutual fund, the commodity pool is a group of commodities which can be invested in. No one person has an individual account; funds are combined with others and traded as one. The profits and losses are directly proportionate to the amount of money invested. By entering a commodity pool, you also gain the opportunity to invest in diverse types of commodities. You are also not subject to margin calls. However, it is essential that the pool be managed by a skilled broker, because the risks of the futures market are still present in the commodity pool.

Buying and selling in the futures market can seem risky and complicated. Futures trading is not for everyone, but it works for a wide range of people. This overview has introduced you to the fundamentals of futures. If you want to know more, and are inclined to invest, be sure to utilize an expert on financial investments.