In the world of finance, there are a lot of different methods and tools for generating significant financial growth if you play your cards right. One of the best things you can do as investor and trader is diversify your portfolio in a meaningful way.
This will help mitigate risk and protect you from losing significant capital all at once. One of the ways to do that is supplement your stock portfolio with futures contracts.
When you trade futures, you are buying and selling contracts for an asset, like grains or oil. This is different from stocks, which are ownership stakes in a company.
With futures, you are trying to hedge against price movements and benefit from increased liquidity. It is a different kind of investing, and involves different markets. Therefore, it’s a good way to diversify. However, it’s also a good way to maximize growth.
Futures Trading 101
Futures trading is the buying and selling of contracts that obligate the parties involved to trade an asset at a predetermined price and date.
These contracts are traded on regulated exchanges, and can be for a wide range of assets, such as commodities, financial instruments, and currencies. When you trade futures, you need to understand certain terms and components of conduction transactions.
For one, futures contracts have standardized. That means that they have predefined specifications, including the quantity, quality, expiration date, and method of payment. This standardization means that transactions are transparent and efficient.
When you trade futures contracts, you can control larger positions with a smaller upfront investment. This is known as a margin, and it gives you leverage. Having leverage is good for expanding your profits, however it can also increase your losses.
You can take either a long position or a short position. A long position is when you expect prices to rise, and a short position is when you expect them to fall.
Timing is everything when you trade futures. You want to purchase a futures contract at a lower price than what you predict it will be. Conversely, you want to sell at a higher price than what you predict it will be. The fact that you buy in advance at a locked in price protects you from price fluctuations.
Advantages of Futures Trading
There are several advantages to trading futures. To start with, futures markets are highly liquid. This means that you can enter and exit positions more easily than with stocks. This liquidity ensures efficient price discovery and lots of opportunities for trading.
It is also more complex, so you will have to do your research and keep your finger on the pulse of the market at all times. However, the added liquidity and freedom to make trades is one of the best things about futures trading.
It’s all about speculating on price movements. When you are able to correctly identify advantageous market trends, you can make significant profits. Additionally, the extra leverage you get from making those profits will help with other trades and help boost your potential returns.
Diversification is a big part of a successful investing strategy. When you have too many investments in one industry, you can lose a lot if that industry goes sour. However, if you have your investments in several sectors and markets, then you are less exposed.
The futures market is separate from the stock market, since it’s not about having a piece of companies. Therefore it’s a good way to diversify.
The other way that it’s protecting you from risk is through hedging. Since you are setting a price in advance for an asset, you are protected from any price fluctuations.
Yes, the price could fluctuate in your favor in the meantime, but with futures you take the sure thing. So if you invest in a commodity like oil, you can lock in a price before it adversely fluctuates.
You can trade in futures in markets all around the world. There are more opportunities for profitable trades because you aren’t limited to your local market.
If you think the price of grain is going to move, then you can make trades in several markets to maximize your profit. It also allows you to profit from declining markets. You can make gains, even if the overall market is bearish by accurately predicting price changes.
Things You Need to Consider When Trading Futures
Like any investment, while there is the potential for growth, there is also some risk. You need to do everything you can to mitigate risks, which include implementing appropriate risk management strategies.
First off, make sure that you get educated and do your research. You need to understand how and why prices fluctuate for the assets you are trading. Futures are not for novices, so you should always be analyzing the market for trends that you can take advantage of.
There are also some risk management steps you can take that will protect you. For instance, setting stop-loss orders with your broker or with your online platform will help you exit when a situation turns disadvantageous.
This will minimize your losses. You can manage your leverage to protect your capital, and take diversification positions with the assets you trade.
You should also make trades only on the data you analyze. This takes discipline and emotional control. You can’t get greedy and overextend yourself. You can’t get mad and short an asset that you should be holding.
You need to be methodical and patient, which can be surprisingly hard to do when you have your money on the line. The best approach is always one that favors thoughtful analysis and a long-term approach as opposed to trading on a whim.
As you can see, futures trading is a great way to diversify and grow your portfolio. However, it’s not as easy as it sounds, and you should have a good grasp of market fundamentals before you get into it.
However, with a sound strategy and by following some key fundamentals, over time you can find success.
