Q: What’s the difference between stocks and futures?
A: Trading stock involves bringing people with extra capital together with those who need capital to develop a business. They facilitate the transfer of ownership of the corporations. Property rights change hands. Whereas trading futures brings people together to transfer the price risk associated with the ownership of some commodity, like wheat, or a service, like an interest rate. No property rights to a physical commodity change hands at the time the futures contract is entered into. In many ways, this makes trading futures vs. stocks much simpler in terms of taxes, execution, short selling and analysis.
Q: How can I sell a futures contract before I own it?
A: It is just as easy to sell first and then buy back later because a futures contract is an agreement to make the stated exchange at some time in the future. Selling first is referred to as shorting or selling short. To offset your obligation to deliver, all you need to do is buy back your contract(s) prior to expiration.
Q: How do I determine how much capital I need to trade a particular contract?
A: There is no absolute number. However you must be able to meet initial margins and margin calls up to your maximum base loss point. That question can be answered only after determining the size of your trade advantage and the percent of capital you’re willing to risk on each trade. If you use common sense, do your homework to get the best estimate possible of your trade advantage, and then risk small amount of money, you can have a profitable trading experience starting with as little as $10,000. If you’re trading contracts with relatively small market values (for example, many single stock futures), you could start with even less.
Q: What are margin and leverage?
A: Margin is the equivalent of a ‘good faith’ deposit. It’s a small percentage, usually between 2% and 10%, of the value of the contract that is deposited with a broker. Margin deposits are set by the exchange and are subject to change with price movement and market volatility. Leverage is the ability to use a small amount of money to make an investment of greater value so that small price changes can result in huge profits or losses.
Q: What’s the difference between the roles of speculators and hedgers?
A: Hedgers are interested in the products of the futures contracts. They can be producers, like farmers, mining companies and oil drillers. Or they can be users, like bankers, paper mills and oil distributors. In general, producers sell futures contracts while users buy them. Speculators, trade futures strictly to make money. Typically, speculators trade futures contracts, but never use the commodity itself. Speculators may either buy or sell contracts depending on which way they think the market is going in a particular commodity.
Q: What tools do I need to trade?
A: Before traders can decide what tools to use to trade, they need to decide on their approach to trading. How much money are you willing to risk? How frequently do you want to trade? How much time and money are you willing to invest in the trading process? Should you use a broker? These are just some of the question that should be answered before deciding on what tools to use. The tools needed to trade vary from person to person. Everybody has their own approach to trading and uses tools tailored to their approach.
Q: What’s the difference between fundamental and technical analysis?
A: Fundamental analysis is concerned with changes in supply and demand factors, which influence the price of the future being traded. Technical analysis focuses on patterns in the movement of price itself, as well as other market specific data such as volume and open interest.
Q: What does volume indicate?
A: Volume is the total amount of purchases or sales, not of purchases and sales combined. Each time a new market position is established, the total volume increases by one. Volume helps measure the strength of price movements. For example, volume usually drops off before prices peak. Volume also helps to evaluate the course of an existing trend. After a market top, it’s common to see a sharp down day on heavy volume.