What Is Futures Contract? Definition, Mechanics, and Trading Strategies!

By reading the article “What is Futures Contract” in the financial markets which is published in Adaas Investment Magazine, you will get acquainted with Futures Trades and its usages in general. This level of familiarity can be enough when you need educational information about this topic.

Futures Contract Definition

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Before studying the definition of a futures contract, one should be aware of the nature of trading derivatives in financial markets.

What are Trading Derivatives?

In financial markets, derivatives are assets that are valued by another asset. For example, securities derivatives traded in international financial markets are valued by the valuation of the stock-backed company and simply put, the value of each stock is a function of the value of the backing company.

Futures contracts

Now that you are familiar with the concept of derivatives, you will better understand the nature of futures contracts. A futures contract is a derivative trading instrument in the financial markets that sets the buyer and seller of a trade for the future.

In a futures contract, the seller sells a tradable instrument to the buyer in the future so that the price, date, and other components of the transaction are compiled and recorded at present.

For example, the seller sets a contract for the sale of a bitcoin cryptocurrency at twice the daily price for the next 3 months for the buyer. This process is called futures trading in the financial markets.

What are the uses of the Futures Contract?

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Innovation of futures contracts was established in 1972 in the agricultural and fossil fuel industries. With this contract, farmers could sell their produce at present and receive income from it if they deliver the product to the buyer a few months later according to the contract.

Simply put, a futures contract is a good strategy for buyers or sellers who want to pre-purchase or pre-sell an asset at the current price. This strategy reduces the risk of price fluctuations for people.

One of the most important applications in futures contracts is the Speculation in different financial markets. As you have seen many times on most trading platforms, futures are traded in the Futures section.

In the futures market, there is a downside market for traders, also known as the two-way market. To better understand the issue, you should read the difference between spot and futures markets in a concise and useful way!

The difference between futures and spot markets

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In short, in the Spot market the buyer receives assets after the payment is completed. But in the futures trading market, traders make payments while the goods are not received instantly.

In the futures trading market, trades take the form of long buy and short sell positions. This feature allows speculators to make a profit in the downtrend markets through the short-selling position. This feature is not available in Spot markets, and traders can only make a profit by buying at a lower price and selling at a higher price, which in financial market terms is a one-way market.

Types of futures contracts

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Futures contracts in the financial markets are divided into two categories, which are described below.

Financial futures contract

These contracts include assets that are traded in a variety of financial markets. Assets such as stock shares in the stock market, currency pairs in the forex market, cryptocurrencies such as bitcoin, and so on.

Commodity futures contract

A variety of physical goods such as raw materials such as iron and textiles or agricultural products are included in this category of futures contracts. In these contracts, due to physical delivery, the goods must comply with the quality and quantity standards of the parties to the contract, and also the important components of the time and place of delivery in the future contract of goods must be specified.

futures contract without expiration dates

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As you have read so far, the futures derivatives trading instrument sets a clear settlement time for both the buyer and seller. But there is another type of futures contract that introduces a futures contract with no expiration date.

Another difference between these contracts and futures contracts with an expiration dates is the possibility of using trading leverages up to 100 times the traders’ deposits. A very important point for traders is how to calculate and work with trading leverage tools. Forex trading market leaders introduce this feature as a double-edged sword to help traders make more profit or go bankrupt.

What are the benefits of futures trading?

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We are sure that after studying this tutorial from the beginning until now, you have created a clear picture in your mind of futures contract trades and their nature. In the following, while introducing the benefits of the futures contract, you will read a review of the previous contents.

Risk coverage

One of the most important applications of a futures contract for a buyer or seller is to cover the risk of their trades. This phrase means the maximum reduction of trading risk that is a function of price fluctuations.

Appropriate liquidity

Liquidity is a very important factor for traders because it indicates the speed of entry and exit from the market. The futures trading market, has a higher liquidity than spot market.

Two-way market

It is possible to make a profit on futures contracts in the rise and fall of asset prices. A very useful feature that the spot market does not have.

Trading leverage

Leverage allows the trader to record a trade with a deposit larger than their actual deposit. This feature is also not seen in the spot trading market and is a positive feature for the futures contract.

Minimum deposit and money supply in futures contracts

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Traders who wish to operate in the futures trading market must guarantee the number of their financial deposits according to the terms of the contracts.

In the Spot market, traders own goods. It means that capital is lost if the asset price becomes 0. But in the futures contract market, price changes depending on the leverage, the amount of the trade commission, and so on make a trading position profitable or unprofitable.

Futures trades increase the trader’s deposit if the price moves in the direction of the trading position, and this in the opposite direction reduces the deposit capital and makes a loss. If the deposit is less than the minimum amount of the guarantee number, which is a function of the terms of the futures contract and exchange commissions, to continue the contract, the trader or investor does not matter whether they are a buyer or a seller, must increase the guarantee deposit above the minimum and if the amount is not increased, the trading position will be liquidated.

The end words

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At Adaas Capital, we hope that by reading this article you will be fully immersed in the futures contract in financial markets. You can help us improve by sharing this article which is published in Adaas Investment Magazine and help optimize this article by submitting your comments.

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