|
Every week at seminars I meet students who want to start trading in Futures. Some even have accounts open, but just don’t feel ready to start or feel a bit intimidated. The basics of futures markets have been covered in newsletter articles in the past, and in considerable details in the Hot Commodities Summit, the CD recordings of which are available for purchase.
However, to give some of you a bit of a push, it is worth talking about some of the basics of futures trading, which this and subsequent articles will address. There are some fabulous trading opportunities showing up in the commodity markets at present, and more will be coming as the year rolls to a close. So if you have been putting your futures debut off, procrastinate no longer.
The first thing to realise about futures is that they are a trading instrument, just as CFDs, or options are. As it is highly unlikely that you have either the desire or the capacity to buy and sell a commodity such as Oil or Gold, you need an instrument to trade it with. So you use futures. You could use options or CFDs as well, but futures are the most profitable.
To illustrate, if you wish to trade in a stock such as AMP, and you identify an ABC short trade on your price chart, you work out the details of the trade and call your broker. However, you don’t sell the physical shares, rather you place an order to sell CFDs.
Chart 1 – Trading With CFDs
click chart to enlarge
The process is exactly the same if you wish to trade in a commodity such as Gold. If you identify an ABC long trade in Gold you don’t ring your broker and place an order to buy a quantity of Gold bars; rather you will buy a Futures contract.
Chart 2 – Trading With Futures
click chart to enlarge
As you can see, a bar chart of AMP is exactly similar to a bar chart for Gold. If the label wasn’t on the chart you would have no way of knowing which was which. The only difference is in the trading instrument used.
Now we reach the first difference between the two instruments. Using CFDs is quite straightforward, as 1 CFD represents 1 share. However, 1 futures contract does not represent 1 unit of the commodity – in this example, 1 oz of Gold. A futures contract represents a basket of that commodity, much in the same way that you buy a punnet of strawberries at the supermarket, not a single strawberry.
So in order to trade futures it is necessary to know the size of the ‘punnet’. To do this you need to look on the website of the exchange where it is traded. For Gold this is the New York Mercantile Exchange, or NYMEX. If you take the trouble to look it up, you will find that 1 contract for Gold contains 100 oz.
If you have ever traded Options you will be familiar with the idea of contract size. 1 options contract over Australian shares controls 1,000 shares, and in the days when Individual Share Futures were traded, 1 futures contract for shares was also worth 1,000 shares.
Spend some time checking out the contract size of a number of commodity futures, and next time we will talk more about the basics of futures trading.
Knowledge is Power!
Tim Walker
|