|
|
Read Articles:
|
|
| Day trading, futures trading, forex trading, and investing articles for free.Feel free to browse all our great articles. Thanks for looking! Here you will find information and articles about trading, day trading, futures trading, forex trading, and more. Whether investing for the long term or day trading for daily income, trading requires discipline, patience, and more importantly, a plan. Lets get starting with some futures trading basics. Futures Trading Basics by: Anthony Schall
Most people know the concept of buying a stock. One must choose a company, buy the stock at a set price, wait for the stock to increase in value, and sell for a profit. Some people buy stocks for investing purposes. Some people buy and sell stocks multiple times during the day for income purposes. When a stock is bought and the price increases by one dollar, the profit is one dollar. What most people are unfamiliar with is futures trading and the leverage behind each trade. Futures trading can be risky but very rewarding if one possesses the knowledge, skills, and discipline. Even though futures trading is risky, trading skills are important because one must be able to manage his or her own money in an up or down market.
Futures are traded as contracts. What is a futures contract? According to the National Futures Association, a futures contract is a legally binding agreement to buy or sell a commodity or financial instrument at a later date. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity. The only variable is price. Price is the only component that will change. All other components stay the same.
There are two types of futures contracts. The first is physical
delivery. Every futures contract has an expiration or settlement date. On
that particular date, if a person owned, for example, one contract of
grains, 5,000 bushels of grains would be delivered. Most people would not
like a huge delivery to show up at their doorstep, so most futures
brokerage firms only perform a cash settlement. Cash settlement is the
second type of futures contract. Instead of physical delivery the person
whom bought the contract of grains would either take a profit or a loss at
the current value. If someone bought a contract of grains and the price
rose to a higher level, upon expiration, the person would take the cash
value as profit.
All futures contracts have a different value and size. One
wheat contract is the equivalent of 5,000 bushels of wheat. One pork
bellies contract is the equivalent of 40,000 pounds of pork bellies. There
are also futures contracts for the stock indices like the DOW, Nasdaq, and
S&P 500. The most popular traded contract is the S&P 500 E-Mini
contract. One contract is the equivalent of $50 times the current value.
So if the S&P was quoted at $800, one contract of the S&P E-Mini
would be worth $40,000 ($800 x $50). This is called leverage. For an $800
investment one could have control of $40,000. If a trader was to buy one
contract at $800,
and the price of the S&P happened
to rise to $801, the difference is $1. Since the leverage is 50 times the
value, the profit would have been $50. The original investment of $800 was
worth $40,000, so when the price increased to $801, the value is now
$40,050 ($801 x $50). The result is a $50 profit for a $1 change in price.
The number of contracts traded is not limited to just one. Two, three,
ten, twenty, or even one hundred contracts can be bought and sold. The
amount of leverage one can have is a powerful thing because with a small
account size, one can trade a large value.
There are two basic strategies when trading. There is buying, also called going long, and there is selling, also called going short. A person whom thinks the market will be going higher, will go long. A person whom thinks the market will be going lower will go short. It is not necessary to buy a futures contract before it can be sold. The contracts can be sold before they are bought. The opposite of what most people would think of doing. When shorting the market with the expectation of it going lower, it will be required to buy the contract back before the
settlement date. When shorting, the math on profit and loss is the
exact opposite of buying or going long. If someone went short one contract
of S&P E-Mini at $800, then buys it back at $799, the profit would be
$50. This is extremely important with trading. The market is not always
going higher, so going short gives one the opportunity to make money when
the market is going lower. When trading, there are various reasons to
either go long or go short. Technical analysis is very popular and it is
the study of historical chart patterns. It is said, patterns in a chart
will repeat over time. Certain patterns will have the result of a price
movement either higher or lower. There are also what are called support
and resistance lines. These lines can be drawn on a chart to show levels
of price reversals. A support line is used when the price is going down.
At the support line the price movement has a tendency to reverse and go
higher. The same is true with resistance lines. A resistance line is used
when the price is going higher. At the resistance line the price has a
tendency to reverse and go lower. Price patterns and support and
resistance lines are only the basics of technical analysis. These tools
are used in combination with many other indicators and techniques to
predict a market's direction.
The futures market in the past was only traded by the professionals
working in the pits of the exchanges. Now in the electronic age, anybody
with a computer can trade futures. There are many online brokerages who
offer futures trading. Most brokerages will have either a web based
trading platform, a software version, or both. The possibility of trading
is only limited to the internet. One can trade from any location that has
an internet connection. Some brokerages even have cell phone applications
allowing someone to place or monitor trades on the go. For the serious
trader who requires quick transactions, a direct access platform is
essential. A direct access trading platform allows the user to place a
trade directly to the market of choice. Some brokerages act as a middleman
and the transaction is routed through them, then to the market. This can
have a delay in the transaction.
The basic order types used when buying or selling futures contracts
or any other stock are the market order, limit order, and stop loss order.
A market order is an order to buy or sell immediately at the current
price. This order is used when it is necessary to get into a trade right
away. A limit order, on the other hand, is an order set at a specific
price. If the market is at a level and an individual would like to buy or
sell at a specific price, a limit order is used. If the S&P was
trading at $820, and someone felt a good buying opportunity was at the
$800 level, a limit order to buy would be placed at $800. If the price
dropped to $800 an order would automatically be placed. The most important
order type is the stop loss order. A stop loss is used as protection when
the market moves in the opposite direction intended. This order will be
set at a specific price level and have a predetermined loss. If the market
moves against the trade and the stop level is met, the order would execute
and immediately close the trade preventing further loss. This is
important, especially when trading futures.
When trading futures contracts, the potential to lose more money than originally invested is very possible. For example, buying one contract of the S&P E-mini may cost $800, but if the price would happen to fall to $780, the loss would be $1000. Using the math previously explained, at a $20 loss multiplied by $50 is $1000. This is where risk management plays a key role. It is important to place protective stops at a level to reduce the risk of the trade. Normally a trader will risk less than he or she is trying to profit. For example a trader may risk $250 for a potential $500 gain. When establishing a risk management strategy, it is important to risk less than the profit objective. Using this method, a trader who had winning trades 50% of the time would be profitable. It is even possible to win less than 50% and still be profitable. For a trader to be successful, there has to be a plan. There has to be a reason to get in and out of a market, and set profit and loss objectives. Successful traders do not take random trades. Using technical analysis and other tools, a trader will only take the high probability trades. A trade that is high probability is one in which may have an 80% chance of winning. A trade with less probability is not worth taking. The combination of all the risk reward aspects and proper planning and discipline will make a good trader.
Futures trading can be confusing at first, but with a little study and practice, the results can be a valuable thing. The economy is always changing and even though futures trading is risky, trading skills are important because one must be able to manage his or her own money in an up or down market. Whether investing for long term or day trading for income, trading skills will help one build wealth over the long-term.
References:
Investopedia ULC. (2009). Futures Fundamentals. Retrieved April
7, 2009, from
http://www.investopedia.com/university/futures
| |||||
|
All Rights Reserved - 2010 - www.alltopics.info |