With the persistent downward movement in the global stock market, the allocation of some portion of investment capital to futures trading can provide a means of achieving greater portfolio
diversification and a potentially higher overall rate of return on investments. Unlike investment in equity, a trader in futures market can make money when the market goes down as well as when the market goes up. There are also a number of ways futures and options on futures can be used in combination with other investments to pursue larger profits or to limit risks.
*WHAT IS A FUTURES CONTRACT?
Futures contracts are legally binding agreement to buy or sell a commodity such as metals or financial instrument such as stock indexes at a later date. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. There are two types of futures contracts, those that provide for physical delivery of a particular commodity and those that call for an eventual cash settlement. The commodity itself is specifically defined, as is the month when delivery or settlement is to occur. A july futures contract, for example, provides for delivery or settlement in july.
During the last two decades following the advent of microcomputer, participation in futures trading by individual traders has grown tremendously. Trading software has proliferated as an increasing number of traders have embraced online trading methods to participate in the global financial markets.
*TRADING THE FUTURES MARKET
Futures' trading is a technique whereby one can buy and/or sell a variety of raw and processed commodity items, as well as contracts on financial instruments, stock indices, and even individual stocks, for anticipated delivery at some point in the future. A person who buys a security futures contract enters into a contract to purchase an underlying security and is said to be 'long' the contract. A person who sells a security futures contract enters into a contract to sell the underlying security and is said to be 'short' the contract. The price at which the contract trades[the 'contract price'] is determined by relative buying and selling interest on a regulated exchange.
In order to enter into a security futures contract, you must deposit funds with your brokerage firm equal to a specified percentage[usually at least 20 percent] of the current market value of the contract as a performance bond. Moreover, all security futures contracts are marked-to-market at least daily, usually after the close of trading. At that time, the account of each buyer and seller reflects the amount of any gain or loss on the security futures contract based on the contract price established at the end of the day for settlement purposes[the 'daily settlement price']. For example, E-minus, like other futures are traded in units called 'contracts'. These contracts represent a bidding agreement to buy or sell electronic mini lot of a future contract at a specified price. You can buy contracts on oil, cotton, pork, bellies etc. Using E-mini S & P 500 futures index for our illustration, you earn [or lose] $50 per point per contract and pay a commission of $6. 20 per round trip.
Each movement of the contract between prices at which profit or loss is recognised is called a 'TICK'. For instance the S&P E-mini ticks like this:1422. 00, 1421. 75, 1421. 50, 1421. 25, 1421. 00
In other words it is divided into 4 ticks per point. Each full point is worth $50 per contract. Each tick is worth $12. 50. So if you made 6 points on 2 trades of 5 contracts each, your profit picture would look like this: 2 x 5 contracts x 6 points
=60 points x $50 =$3, 000
The only thing we have not taken into account in the above equation is the market maker's commission. Assuming the brokerage deal of about $6. 20, the commission would be $62. 00 for the trades[$6. 2 x 10], so your total profit on the 2 trades would have been $3, 000 - $62 =$2938.
The NASDAQ E-mini contracts are worth $20 per point. The NASDAQ E-mini ticks like this: 2420. 00, 2419. 50, 2419. 00.
Notice that the NASDAQ is only divided into 2 ticks per point. Each full point is worth $20. Each tick is worth $10 per contract. To trade E-minus or any futures contract for that matter you have to maintain a certain level of cash in your trading account. That amount is called 'Margin', if your broker requires a $3, 000 margin per contract [very common amount with many brokers for short term trading accounts then you would need $6, 000 in your account to trade 2 contracts. You will also need some funds over and above that as a cushion, just in case the trade does not go your way. So as in the above example, if you had a $3, 000 margin and wanted to work with 2 contracts, you would need to have about $8, 000 in your account [$6, 000 for the margin and $2, 000 cushion]. You could do it with less, but you will be required to have at least the margin in your account or you won't be allowed to make any 2 contract trades. Commissions are often expressed in terms of 'Round Trips'. That means a buy and sell, or a sell and buys. Each time you get in a trade and then back out is a round trip. You will see various prices all over the net for these commissions. Some brokers will give you a very low commission rate, but a higher margin. It is worth it to you as a trader to pay a slightly higher commission if you can get a nice low margin! The low margin will allow you to play with more contracts and increase your profits with less money in your account.
*PARTICIPATION IN FUTURES MARKET
Individual, investment group or corporate organisation can trade in any of the major futures market of their choice. This is made possible by the advent of online trading. Online trading allows traders to actively participate in buying and selling of futures and equity in any major stock exchange market across the world. The trader is link up directly into the market through software called platform.
A platform is the software you will actually use to make trades with. Your demo account is a platform. When you go live you will be using the same software or platform [or at least you should learn the platform, is part of the battle in becoming a trader] that you used with your demo. Since trading in the global futures and equity market is real time, therefore, an aspiring successful trader must have the right tool, system and attitude to succeed. Traders must also have some level of capital and the relevant knowledge required to analyse the market proper. There are two ways to carry out market analysis. [a] Fundamental analysis [b] Technical analysis.
Fundamental analysis focuses on external factors such as interest rates, the general economic performance, and social and geo-political factors that drive supply and demand that affect the performance of companies that makes up the component units of financial markets. Three main factors that impact stock market movements from a fundamental perspective are:
[a] GOVERNMENT POLICY AS IT RELATES TO INTEREST RATE: The cost of borrowing within the local economy. Since this is a direct cost to corporate organisations, it has an effect on profitability on companies operation.
[b] ECONOMIC INDICES: These are the indicators that show the state of health [performance] of the economy of the country where the market is situated in one hand and the state of world economy in general.
[c] GEO-POLITICAL FACTORS: This is the extent of social stability across the world. The effect of events such as crisis, change in government, natural disaster, threat of terrorist attack, policy changes play a significant role in determining the ability of corporate world to operate profitably. While technical analysis involves the forecasting of stock price movement based solely upon statistics and price pattern. Simply put, technical analysis is the analysis of the market based on price action. While fundamental analysis looks at economic factors and geopolitical conditions [such as economic numbers, capital flows and key political events] in an attempt to forecast exchange rates;technical analysis relies on the statistics and patterns in price movement for its forecast. Technical analysis has gained great popularity in recent history, especially as trends in computerized trading continue to develop and active traders continue to refine their strategies to best assess what is going on in the market at all times. Coinciding with the increasing popularity of computerised trading across all investment arenas is the ability for traders to employ technical analysis. As markets tend to become inundated with information and as charting applications are able to provide traders with an increasing array of data, technical analysis has become both practical and relevant. I n today's marketplace, technical analysis has become an essential tool for any aspiring trader.
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