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How Futures Contracts Work: A Complete Guide

If you’re a trader or investor, chances are you’ve heard of Futures contracts. But what exactly are they and how do they work? In this article, we’ll explore everything there is to know about Futures contracts, from their definitions and main characteristics, to the ways in which they are traded and their implications in the financial market.

What is a Futures contract?

A Futures contract is an agreement between two parties to buy or sell an underlying asset (such as a commodity or currency) at a fixed price on a specified future date.

Unlike spot markets (where buying and selling take place immediately), Futures contracts are traded on regulated markets and require the asset to be delivered on a specific future date. Futures contracts are characterized by a high level of financial leverage, which means that even a small change in the price of the underlying asset can lead to large profits or losses. In addition, Futures contracts are standardized, meaning that each contract has exact specifications for the underlying asset, price, contract size, and expiration date.

How do Futures contracts work?

To understand how Futures contracts work, it is useful to consider an example. Imagine that you want to buy a Futures contract for gold. The current price of gold is $1,500 an ounce, but you believe that the price will increase in the future. Then, buy a Gold Futures contract at a price of $1,550 an ounce, with an expiration date of six months. After six months, the price of gold rose to $1,700 an ounce. Because you bought the Futures contract at a lower price, you can sell gold at the pre-set price of $1,550 an ounce and earn the difference of $150 an ounce. However, if the price of gold had fallen to $1,450 an ounce, you would have suffered a loss of $100 an ounce. Futures contracts can be used for hedging purposes (i.e. to protect against price fluctuations), for speculation (i.e. to try to profit from price fluctuations), or for both.

How are Futures contracts traded?

Futures contracts are traded on regulated markets, such as the Chicago Mercantile Exchange (CME) or the Intercontinental Exchange (ICE). Each contract has a real-time market price, which is determined by the offers and demands of market participants. To negotiate a Futures contract, you must open an account with an authorized intermediary, such as a bank or online trading firm. Once an account is opened, you can buy or sell Futures contracts based on your trading or investment strategies. Futures contracts are available for a wide range of underlying assets, including commodities, currencies, stock indices, and even cryptocurrencies such as Bitcoin.

Conclusions

In summary, Futures contracts are a popular financial instrument among traders and investors, since they offer the opportunity to profit from fluctuations in the prices of the underlying asset. However, Futures contracts are also characterized by a high level of risk, which means that it is important to fully understand their characteristics and their operating mechanisms before investing. Unpublished tips 1. Consider using technical analysis tools, such as charts and indicators, to identify the price trends of the underlying asset and improve your trading strategies. 2. Consider using stop losses to limit your losses in the event of unfavorable price fluctuations. 3. Remember that Futures contracts are subject to margin calls, which means that you may need to deposit additional funds into your trading account if your losses exceed your initial margin. Make sure you fully understand the margin requirements before you start trading Futures contracts.

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