The honeymoon period of learning easy things is slowly coming to an end.
Slowly we will shift our focus from basic and easy topics to much
harder and advanced topics. Though the topics may be advanced, but don’t
worry, they will be extremely easy to understand on this blog. At
Moneypalm, unlike other educational blogs or sites, our focus is less on
using difficult jargons to further complicate things and more on using
simpler terms and references which makes understanding the topic a
cakewalk for our users who are also our friends.
So after the much loved self-praise in the above paragraph, let’s get down to the work.
Today we will learn the basics of Futures trading. So what is a “Futures Contract” or in simple market term “A Future”?
A futures contract is an agreement between a buyer and a seller. Here
the buyer agrees to purchase from the seller, a fixed number of shares
in form of lots, at a pre-determined time in the future, for a
pre-determined price. The details of the contract are agreed upon when
the transaction takes place on the trading terminals. Since futures
contracts are standardized in terms of expiry dates and contract sizes,
they can be freely traded on exchanges through the trading terminals.
Futures are available for trading in several different asset classes like:
After the basic understanding of the futures, we can now more further
and understand futures in detail. But before doing so, let us first
understand the pros and cons of trading in the futures market.
So here are the pros of trading in the futures market:
1. As a trader in the stock, currency or
commodity market, the futures give us a fairly good, if not a correct
idea of the prices of the underlying stock or commodity or currency.
2. Futures are mainly used as a hedging
instrument to protect our investment from uncertainties of the markets
and minimising our risks.
3. As a trader in the futures market, you
do not have to pay entire value of the futures purchased, instead you
just have to pay a small margin of the whole amount. This helps in
better utilisation of your funds and you can trade big values with
smaller amount in your account.
We have already gone through the positives of Futures trading, now
let’s come to the negatives too. After the rosy positives of the
Futures trading, now let’s understand the negatives.
1. Future is a derivative product and is
far more difficult to understand than the cash market. So a trader with
the basic knowledge of the markets, will find it extremely difficult to
trade in futures and might end up making losses. So it you are new to
the markets, we will advise you to avoid futures, until you thoroughly
and deeply understand it.
2. The leverage that we get from the
exchanges for trading in the futures was one the positives we listed
above. Sadly, the same leverage is also the negative of trading in the
futures. Leverage can be extremely dangerous if we make losses as the
losses increase multiple folds in futures when compared to the spot
market and even a single wrong trade is capable to wipe out the whole
There are always two sides of a coin. Similarly, everything in this
world has its positives and negatives. Understand them!! Analyse both
the positives as well as negatives, taking in view your investment
needs, risk appetite and risk to return ratio.
So if you feel that the benefits of trading in futures are more than
the risks associated with it, than you should probably go through the
next paragraph and our upcoming posts on futures trading.
Now let’s understand few of the characteristics of the futures contracts:
1. Lot/Contract size: The futures
contracts cannot be traded for a single share. The exchange fixes a lot
size of a particular underlying stock and differs from stock to stock.
This means when you trade in futures, you have to buy or sell a
specified number of shares as fixed by the exchange. The same goes for
index futures, commodities and currency futures.
2. Duration: Futures contracts are
available in durations of 1 month, 2 months and 3 months. Once a
particular contract expires, another contract is introduced for each of
the 3 months.
The month in which a particular contract expires is called the contract
month. New contracts are issued on the next day after expiry of the
3. Expiry: All 3 contracts are traded
concurrently on the exchange and expire on the last Thursday of their
respective contract months. If the last Thursday of the month is a
holiday, they expire on the previous business day.
We hope that the basic concept of the futures is now clear to you. We
will take up more advanced topics in Futures in our upcoming posts. But
for that the basic concept of futures should be crystal clear to you.
Do not shy away from asking the questions as the answers will help
further clarify any doubts that you might have. Thanks for all the time
and the support that you give us. We will be back soon with a new topic.