penny stocks > investing in futures > regulation of futures trading

What to Look for in a Futures Contract?

Although the average trader is unlikely to ever approach them, exchanges and the CFTC establish limits on the maximum speculative position that any one person can have at one time in any one futures contract. The purpose is to prevent one buyer or seller from being able to exert undue influence on the price in either the establishment or liquidation of positions. Position limits are stated in number of contracts or total units of the commodity.

The easiest way to obtain the types of information just discussed is to ask your broker or other advisor to provide you with a copy of the contract specifications for the specific futures contracts you are thinking about trading. Or you can obtain the information from the exchange where the contract is traded.

Understanding the risks of futures trading

Anyone buying or selling futures contracts should clearly understand that the risks of any given transaction might result in a futures trading loss. The loss may exceed not only the amount of the initial margin but also the entire amount deposited in the account or more. Moreover, while there are a number of steps that can be taken in an effort to limit the size of possible losses, there can be no guarantees that these steps will prove effective. Well-informed futures traders should, nonetheless, be familiar with available risk management possibilities

Choosing a futures contract

Just as different stocks or different bonds may involve different degrees of probable risk and reward at a particular time, so may different futures contracts. The market for one commodity may, at present, be highly volatile, perhaps because of supply-demand uncertainties that, depending on future developments could suddenly propel prices sharply higher or sharply lower. The market for some other commodity may currently be less volatile, with greater likelihood that prices will fluctuate in a narrower range. You should be able to evaluate and choose the futures contracts that appear, based on present information, most likely to meet your objectives and willingness to accept risk.

Keep in mind, however, that neither past nor even present price behavior provides assurance of what will occur in the future. Prices that have been relatively stable may become highly volatile (which is why many individuals and firms choose to hedge against unforeseeable price changes)

Liquidity

There can be no ironclad assurance that, at all times, a liquid market will exist for offsetting a futures contract that you have previously bought or sold. This could be the case if, for example, a futures price has increased or decreased by the maximum allowable daily limit and there is no one presently willing to buy the futures contract you want to sell or sell the futures contract you want to buy.

Even on a day-to-day basis, some contracts and some delivery months tend to be more actively traded and liquid than others. Two useful indicators of liquidity are the volume of trading and the open interest (the number of open futures positions still remaining to be liquidated by an offsetting trade or satisfied by delivery). These figures are usually reported in newspapers that carry futures quotations. The information is also available from your broker or advisor and from the exchange where the contract is traded

Timing

In futures trading, being right about the direction of prices isn't enough. It is also necessary to anticipate the timing of price changes. The reason, of course, is that an adverse price change may, in the short run, result in a greater loss than you are willing to accept in the hope that you will eventually be correct.

Example: In January, you deposit initial margin of $1,500 to buy a May wheat futures contract at $3.30 - anticipating that, by spring, the price will climb to $3.50 or higher. Soon after you buy the contract, the price drops to $3.15, a loss of $750. To avoid the risk of a further loss, you have your broker liquidate the position. The possibility that the price may now recover and even climb to $3.50 or above is of no consolation.

The lesson to be learned is that deciding when to buy or sell a futures contract can be as important as deciding what futures contract to buy or sell. In fact, it can be argued that timing is the key to successful futures trading

Related Topics:

Penny Stocks

Beginner Investor

Advanced Trader

Prudent Investing