Futures Trading – What You Should Know
Jun0
Futures contracts as they relate to finance is a simple contract devised to allow someone to ultimately purchase or sell specific commodities that will be delivered at some future time. Generally there are certain dates and time frames which must be met in order to be a valid contract.
These types of transactions are never offered on the usual stock market but you would find them on what is commonly known as the futures exchange. They are not considered to be securities in the strictest sense of the word as stocks or bonds may be. They are a type of derivative.A futures options contract or a commodity option is a derivative as well.
The actual prices associated with the various commodities vary according to the supply and demand. If the pork belly crop is bad this year the prices will likely be high while an over abundance of coco would result in a lower than normal price. The future date is known as the delivery date while the daily bid on the exchange would be the settlement price.
In a nutshell in futures trading, what a contract states is that the holder can take delivery of the commodity at some future date however the futures must be complied with by the settlement date. At the settlement date the seller will deliver the asset to the buyer whether it is coco or pork bellies or whatever. In order to fulfill your obligation prior to the established settlement date you must offset your position by selling if you purchased the futures or buying back if you had a previous short position which ultimately allows you to balance everything out.
An interesting side note here is that if you purchased a futures contract and do nothing what so ever and the settlement date arrives you could end up with a yard full of assets that you really did not want. Unlike stocks and bonds we are talking real time products here.
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Creating A Level Playing Field
May0
Creating a Level Playing Field
It is not a lie to say that trading can be difficult. However, in an effort to make it easier, other traders often resort to taking quick exits sometimes by trying to make 10 pips on each trade instead of earning 100 pips on one. This kind of attitude may seem to be sensible. Moreover, the trader seeks to triumph by playing it safe, which would look like a commendable trait in world of trading. However, instead of making things easier, the trader is in fact making his life more difficult.
Evening out the Odds
The world of forex trading is much like the European roulette. The zero pockets represent the spread and the odds are forever going to be at least somewhat supportive of the house, which in forex is the market maker. Similar to when each additional zero packets lower the players chances of success, every additional pip in the spread can also lessen the chances of success of the trader.
The house always determines the spread and the traders have no control over it; it is only determined by the market maker alone. However, in the world of foreign exchange trading, the traders can increase the size of the playing field, thereby improving their chances of success in trading. This can be done by using exits and stops, longer time frames, and trying for larger gains.
Do the Math
Assume that a trader is trading a currency pair that has a 3-pip spread, which is also a very common size of the spread in the forex market. If the trader just wants to gain 10 pips, it is understood that he or she can lose the spread upon entering the trade. And so, in order to turn a profit of 10 pips, the trader actually requires the exchange rate to move 13 pips in his or her favor, thus 10 plus 3 equals 13.
Knowing what is required to create a winning trade can help traders know what would have to happen to create an equivalent loss. This is also the method on how traders can determine the odds of success or failure.
To create a loss of 10 pips, the trader would only require an adverse move of 7 pips. This is for the reason that a loss of 3 pips is acquired automatically upon entering the trade, again due to the 3-pip spread.
It was also determined that the trader needs a positive move of 13 pips in order to gain 10 pips, but a move of just 7 pips can result in an equivalent of 10 pips. The so-called raw odds of the 10-pip win versus the 10-pip loss for such a trade can be expressed by: 13/7=1.857:1.
As thus, the odds of the success in this example are 1.857:1. This only shows that trying to make money trading for small gains is difficult, not to mention that the playing field is too small. However, traders can improve the odds of any trade by utilizing good strategies and solid risk management.
Changing the Equation
The traders can rearrange the odds, in order to attain a better chance to win at currency trading, by making the playing field larger. If the traders are aiming for larger gains, the spread becomes less essential part of the trade.
Once again, suppose a spread of 3 pips, only this time the trader will be hoping to gain 100 pips as a replacement for just 10 pips. To turn a profit of 100 pips, the trader actually needs the exchange rate to move 103 pips in his or her favor, thus 100+3=103.
More so, to generate a loss of 100 pips, the trader would need an adverse move of only 97 pips since a loss of 3 pips is incurred instantly upon trade entry. The raw odds for this situation, which is a 100-pip win against a 100-pip loss, can be expressed by: 103/97=1.06:1.
Noticeably, the odds are better because they are close to 50-50. However, if the trader is using good trading techniques and risk management, he or she can overcome these slightly negative odds.
The point of changing the equation is to understand that when the playing field is larger, the odds of success also improve significantly. More so, traders who are trying to achieve greater gains have the tendency to hold their trades longer and consequently enter trades less frequently.
Reason Why Not Everybody Does It
Though the prospect of trading for larger gains is favorable, not everybody does it. There are a couple of possible answers: first, these traders do not understand that they are stacking the odds against themselves; and second, they have damaging predetermined notions about the nature of trading itself.
The problem that most traders encounter is that trading is not always what they believe it to be. Each trader has his or her own concept of trading, or even what he or she likes trading to be. Although it is ideal for trading to provide people with riches through minimal effort, trading strategies are not suited for the ideal – they should be applied in the real trading world.
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