What is Futures Trading? | A Complete Guide For Beginners

Introduction to Futures Trading:

What is Futures Trading?

Futures trading is a type of financial trading that involves an agreement to buy or sell an asset on a future date at a predetermined price. The assets could include stocks of a company, a commodity, or other types of financial instruments. 

Futures trading contracts are obligatory in nature, implying that both parties will have to execute the contract on the terms agreed upon. Moreover, since the quantity and price of the asset are fixed, the contract will be implemented despite any fluctuations in the price of the asset due to market volatility. 

How does Futures Trading Work?

Futures trading contracts are standardised contracts in terms of the asset type, expiry date and price. These factors are agreed upon by both parties, the buyer and seller. On the date of expiration of the futures contract, if the price of the underlying asset increases on the regulated stock exchange, the buyer of the contract will benefit from the trade. On the contrary, if the market declines causing the price of the asset to fall as per the stock exchange, the seller will earn a profit. 

Types of Futures Contracts:

Some common types of futures contracts are listed below:

• Stock Futures: 

Stock futures are a type of futures contracts where traders can buy or sell shares of a company at a predetermined price on a future date. These futures contracts allow traders to speculate on price fluctuations without directly owning the underlying stocks. 

• Commodity Futures: 

Commodity futures refer to a type of futures contracts that involve the buying or selling of physical goods (commodities) such as gold, silver, natural gas, crude oil, etc. The price of these commodities is preset in the contract. The most significant advantage of commodity futures is that it allows hedging opportunities against unfavourable price movements.

• Currency Futures: 

The type of futures trading contracts that involve the exchange of one currency for another at a preset price on the expiry date is called a currency futures contract. These are mostly beneficial for traders who want to hedge against risk caused by changes in foreign exchange. 

• Interest Rate Futures: 

Interest rate futures contracts involve hedging against the possibility of fluctuations in the interest rate of the underlying assets. These are usually associated with money market instruments like government bonds.

Difference between Options and Futures:

Futures contracts refer to legal agreements to trade the underlying assets at a predetermined price on a specified future date. Both parties, including the buyer and seller, are obligated to execute the contract on the expiry date as per the terms agreed upon.  

On the contrary, options contracts grant the buyer the right but not the obligation to buy or sell an underlying asset within a specified period. Thus, the decision whether to execute the contract or not can be made depending on the market conditions, unlike futures contracts.

Participants of Futures Trading:

Futures trading is mostly preferred by traders who are:

• Hedgers: 

Hedgers are traders who use futures trading contracts to protect themselves against adverse price movements in the underlying asset. Unlike speculation which is done for earning profits, hedging is done to mitigate the risk. This is a popular risk-management strategy that enables stable cash flows even during market downturns.

• Speculators: 

Speculators are traders who participate in futures trading with the main goal of earning profits from price fluctuations. Depending on the market situation, these traders can take both short and long positions to benefit from price movements in any direction.

• Arbitragers: 

Arbitragers are traders who aim to benefit from price differences between different markets or related financial instruments. For example, they may buy a futures contract in one market where the price is lower and sell a similar underlying asset in another where the price is slightly higher. 

Advantages of Futures Trading:

Futures trading contracts offer a great potential for earning profits. Some other advantages include:

• No Risk of Default: 

Futures trading contracts are legally binding contracts that obligate both parties to execute the contract as per the terms agreed upon. Additionally, futures contracts are traded on regulatory exchanges that act as an intermediary between the buyer and seller. This ensures that there is no risk of default from either of the parties.

• Cost-Efficiency:

In futures trading contracts, traders need not pay the full value of the underlying asset. Rather, they only need to pay the initial margin, which is a small investment amount to take a futures position. This allows investors with lower availability of capital to participate in futures trading, thus proving to be a cost-efficient way of financial trading. 

• Hedging Opportunities:

One of the most significant advantages of futures trading is that it provides hedging opportunities. Traders aim to participate in futures contracts with an aim to safeguard their underlying assets against price fluctuations in the cases of market downturns. This is a strategic way to ensure stable profits despite unfavourable industry dynamics.

• Real-Time Price Discovery:

Futures trading contracts facilitate real-time price discovery of the underlying assets. This is possible because these contracts are actively traded considering updated market news that reflects price fluctuations. Investors can make well-informed decisions with the help of accurate valuations of the assets.

• Increased Transparency:

The most favourable upside of futures trading is that these contracts are traded on regulated stock exchanges. This helps investors feel more confident in the safety of their trades. Moreover, all the conditions of the futures contract including the quantity and price of the underlying asset, and the expiry date, are predetermined. This promotes transparency among both the parties involved.

Ready to experience the benefits of futures trading? Let Univest be your guide!

Disadvantages of Futures Trading:

While futures trading contracts offer various advantages, it is important to consider the downside too. Some disadvantages of futures trading are as follows: 

• High Risk: 

Futures trading involves a high level of risk due to more vulnerability to market trends. Since this involves crucial market uncertainties, many conservative and risk-averse traders might not feel confident in participating in futures trading contracts.

• Complexity: 

Futures trading contracts are comparatively more complex than traditional investing. This is because understanding concepts like contract terms, margin requirements, rollovers, and settlement procedures can be challenging. Moreover, traders are required to utilise fundamental as well as technical analysis, which can be complicated for many traders.

• Emotional Pressure: 

Futures trading contracts are fast-paced in nature. This can lead to emotional responses like fear, hesitation or anxiety, resulting in irrational decisions. Additionally, beginners or passive investors might feel overburdened due to the need for constantly monitoring markets.

• Requires Constant Monitoring: 

The level of volatility involved in futures trading is extremely high. Prices of the underlying assets can fluctuate quickly in response to market events. This requires prompt decisions to be made, demanding traders to constantly monitor market trends and price charts of the financial instruments. Hence, futures trading contracts might not be preferred by passive investors.

• Not Ideal for Novice Investors:

Futures trading is usually not convenient for beginner investors because of its complexity and high level of risk. Moreover, novice traders lack in-depth market knowledge and the ability to make accurate predictions about future price movements. Without these, it can be difficult to make informed decisions for executing profitable futures trading contracts.

Tips for Futures Trading:

Futures trading involves certain risks. It is advisable to be careful and consider these tips to prevent losses:

• Understanding the Basics: 

Before beginning with futures trading, it is extremely important to have a solid understanding of the fundamental concepts involved in it. Due to the complex nature of futures contracts, insufficient knowledge or misinformation can result in huge losses. Therefore, it is advisable to comprehend key concepts like lot size, expiry date, mark-to-margin, hedging, etc.

• Starting Small:

For novice investors, it is always better to start futures trading with a phased approach. Taking smaller positions initially and implementing diverse strategies can help traders gain more confidence. It also helps in practicing futures trading without incurring heavy losses. Once the knowledge and implemented strategies are more defined, one can always choose to trade with more capital.

• Implementing Risk Management Strategies: 

Implementing effective risk management is a crucial step in executing profitable futures trades. This is because financial markets are exposed to adverse conditions that can have a direct impact on the prices of the underlying assets. To navigate through these uncertainties, proper risk management techniques should be implemented.

• Setting Realistic Expectations:

Futures trading contracts do offer a great potential for earning profits. However, it is not necessarily true that every trade will result in financial gains. So, it is better to set realistic expectations to avoid irrational decisions.

• Rational Decision Making: 

Investors might get triggered due to emotional pressure leading to extreme emotions like anxiety or fear due to the highly volatile nature of futures contracts. Thus, it is important for investors to stay calm and make rational decisions on futures trading contracts in the cases of market downturns. 

• Staying Updated:

Futures contracts are highly vulnerable to fluctuations in market trends due to real-time price discovery. All relevant market news regarding financial developments, economic landscape, geopolitical factors, etc. have a strong influence on the market dynamics. Thus, it is crucial to stay updated with the factors affecting futures contracts. 

Conclusion:

Futures trading contracts are a strategic way to access hedging and speculation opportunities. These contracts are extremely secure due to the legal obligations to honour the contract by both parties. Additionally, since these are traded on regulated stock exchanges, traders are confident about the safety of their investments. However, futures trading contracts are highly volatile. It is advisable to consider the risks associated with them before beginning to trade.

Navigate the market uncertainties with expert guidance. Download the Univest app now! 

Key Terms Used in Futures Trading:

• Underlying Asset: 

The financial instrument on which the futures trading contract is based is known as an underlying asset. These could include a wide range of instruments such as stocks, commodities, currencies, or indices.

• Lot Size:

Lot size refers to the minimum fixed quantity of an underlying asset that can be traded in a single futures contract. This quantity is set by the stock exchange and it can vary depending on the type of assets. 

• Margin:

The initial amount of investment required to open a futures position is known as the margin. It includes the initial margin as well as the maintenance margin.

• Expiry Date:

In futures trading, the expiry date is the last date till which the futures contract is valid. After this date, the futures contract is either settled by delivering the underlying asset or via cash settlement, or it is rolled over.

• Mark-to-Margin:

Settlement of all the profits earned or losses incurred in a day is known as Mark-to-margin. This is done on the basis of daily adjustments made in accordance with fluctuations in the market prices.

• Long Position:

Buying a futures contract anticipating the price of the asset to increase till the expiry date of the contract is known as taking a long position. Traders take long positions with the primary motive of earning profit from the price variation between the contract price and the market price at the expiry date.

• Short Position:

Selling a futures contract with an expectation that the price of the underlying asset will decline at the expiry date is called taking a short position. This helps the trader benefit from the price differences between the contract price and the market price at the expiry date.

• Contract Value:

The total value of a futures contract is known as the contract value. It can be calculated by multiplying the lot size of the contract by the price of the underlying asset.

• Volume:

The volume of trade is the total number of trades taking place on a particular day. It is an indicator of the market activity, implying that the higher the volume of the trade, the higher the level of participation of investors.

• Hedging:

Hedging refers to the use of futures contracts to protect the underlying asset against any price fluctuations due to market volatility. It is usually done to safeguard the assets already owned by the trader or the ones that the trader wants to own in the future.

• Speculation:

Speculation involves the utilisation of futures contracts to earn profits from the price fluctuations in the asset due to market volatility. It can be done without having to own the underlying asset.

FAQs for Futures Trading:

1. What is futures trading?

Ans. Futures trading is a type of financial trading that involves an agreement to buy or sell an asset on a future date at a predetermined price. These assets could include stocks of a company, a commodity, or other types of financial instruments. 

2. What are the advantages of futures trading?

Ans. Futures trading offers various advantages to traders like hedging opportunities, increased transparency, and real-time price discovery of the underlying assets. Moreover, it also proves to be a cost-efficient type of trading due to low initial costs.

3. Who are the major participants of futures trading contracts?

Ans. The major participants of futures trading contracts are hedgers, speculators and arbitragers. They execute their trades in the futures market with varying objectives, depending on the risk appetite and investment perspectives.

4. What are the different types of futures contracts?

Ans. The various types of futures contracts include stock futures, commodity futures, interest-rate futures and currency futures. This diverse variety of futures trading contracts offers traders to hedge against unfavourable price changes in the underlying assets.

5. Is futures trading risky?

Ans. Yes, futures trading contracts can be risky due to high volatility caused by market trends. It is advisable to do thorough research and make rational risk-management strategies to navigate these uncertainties.

Disclaimer: This is for general information and education purposes only. The Securities quoted (if any) are for illustration only and are not recommendatory. Past performance does not guarantee any future returns. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

Read Our Articles on the Best Stocks

Best Gold Stocks India

Green Energy Penny Stocks

Best Cement Stocks To Invest in India

What is Earnings Per Share EPS? 

Top Multibagger Penny Stocks For 2025 |  Potential Picks

Fundamentally Strong Stocks on NSE in 2025

Debt-Free Penny Stocks in India 2025

Best Realty Stocks In India 2025

Debt Free Penny Stocks Below 1 Rupee

Also Explore

Explore Current and Previous IPOs

Univest Screeners

Explore Webstories on Univest 

1. Best Time To Buy Dividend Stocks

2. How RBI Policies Affect Dividend Stocks

3. Can Dividend Stocks Beat Inflation

4. What Is The Dividend Aristocrat List

5. Which Indian Psus Offer The Best Dividends

6. Large Cap Vs Small Cap Dividend Stocks