To fully understand futures, you need to know what commodities are. The Merriam-Websters dictionary defines them as "articles for sale". In the financial world, they are often known as raw materials.

Commodities are often items that you see everyday. These include oil, grains, sugar, and many more. These items are bought and sold by investors, producers, and users.

The prices of commodities fluctuate greatly based on supply and demand. When there is less demand or more supply of a product, the price drops. When the demand is higher or the supply is lower, the commodity is in greater demand by the public so the price rises. For example, if there is turmoil in the Middle East, the prices of oil would rise because it would threaten our oil supplies. However, if the Middle East announces that they are going to increase production, then prices would fall because there would be greater supply. These prices are constantly changing and here is where the futures contracts come in.

Futures

Now that you have a little knowledge of commodities, it's time to start learning about futures. Futures contracts are used to buy and sell commodities. They are often referred to as derivatives.

The future contract was invented many years ago to prevent businesses from being affected by the constant changes in commodity prices. When a commodity rises to an astonishing price, a business may be unable to afford to purchase it while making a profit. The future contracts protects them from this. If a company buys a future contract of oil at 11.00 and the price rises to 14.00, then the company still has the right to buy the contract of oil at 11.00. However, fewer than 2% of all futures trades involve the exchange of goods.

Futures are traded in exchanges. These exchanges are located in Chicago, Kansas City, Minneapolis, New York, and Philadelphia. Like the New York Stock Exchange, futures are traded by floor traders. They are usually organized into a ring, also known as a "pit", and compete to get the lowest prices.

For investors, futures provide them with leverage. Leverage is the ability to use a smaller amount of money to make a larger investment. Futures contracts provide a person with the ability to buy a certain amount of that commodity. This amount varies from commodity to commodity. For example, one contract of wheat futures would give you the opportunity to buy 5,000 bushels of wheat. At about $3.00 per bushel, this would cost an investor $15,000 to invest in one future contract of wheat.

There is a way to invest in futures without needing to invest the full $15,000 for a wheat futures contract. This works much like buying on margin with stocks. An investor puts up a certain amount (usually 10% or less) of the full contract price. Let's say that an investor created an account to pay 10% of one wheat futures contract. They would be required to invest $1,500. This is a good example of leverage because the $1,500 is actually acting like it is a full contract of $15,000 worth of wheat.

There is a lot of risk involved in futures investing but there is also a lot of potential for great return on your money. If the price of the commodity rises when you expected it to, you would probably make a large sum of money. For example, if the wheat prices go up 10%, then the investor would make $1,500, a gain of 100% on the initial investment. You must remember that the initial investment is actually acting like an investment of $15,000 by the use of leverage.

However, the risks hit hard when you make wrong predictions. Let's say that wheat production is increased and the prices drop 10%, then the contract would lose $1,500 of its value. The investor would have to add $1,500 to their account because the margin requirement is $1,500. An investor may end up losing much more than they initially invested if prices continue to drop.

When an investor sells their future contract, they are ending their obligation to purchase the commodity. The money can then be kept or used to invest in another future. If the future expires, then the investor has the obligation to buy out the future. If the wheat contract expires, the investor may be stuck with 5000 bushels of wheat!

Like buying and selling stocks, futures also charge commissions. They charge a type of commission called a round-turn commission. Unlike stocks, you only pay the commission once on futures. However, the commission is considerably higher than stock commissions, often ranging as high as 20% of the investment.

Two Types of Investors

When it comes to futures, future traders are often classified into two groups: hedgers and speculators. Hedgers are usually people who are interested in owning the commodity. They use their futures contracts to protect them from price changes that will jeopardize their profit magin. If the prices of a commodity goes up, their profit margin is cut unless they raise the price of the product.

The second type of investor is the speculator. They are the group of people that trade commodities solely to make money. They are not interested in owning the commodity. They hope to make money in the market by betting their money on price moves. If they think a hurricane will hit Florida, they may invest in orange juice futures to profit from the destroyed crop of oranges. Instead of buying the commodity, they hope to sell the contract. Speculators often experience greater risks than hedgers do.

Are futures right for a Buck investor?

Although futures have the potential to make you very rich, chances are that you will fail in futures trading. In fact, 80-90% of all futures traders lose money each year. This is why we recommend you steer away from futures unless you intend on purchasing the commodity or have a strong grasp of the futures market. Because a Buck investor usually invests for the long term, short term gains with huge risks are not necessary to achieve our goals

[an error occurred while processing this directive]