To be successful, investors need to understand every corner of the financial market. When building their investment portfolios, most investors typically focus on things such as:

• Stocks
• Bonds
• Mutual funds
• Exchange-traded funds

There are, however, other financial markets that play a large role in the overall economy. Futures markets are among the most important, though few investors participate in them. Once you understand what they are, you’ll discover why investors should pay them more attention.

What Are Futures?

The origin of the futures market lies in commodities. Those whose businesses produced commodities were looking for a way to manage the risk of the uncertain price range that came from future production. For farmers, gas and oil producers, and miners, futures contracts were the way to answer the problem and meet market participant’s needs.

A futures contract works is a relatively simple way.  When under a futures contract, the seller agrees to sell a fixed amount of a certain commodity to the contract buyer on a particular day in the future. The price that the buyer agrees to pay the seller is set based upon the futures market price at the time both parties enter the contract. This eliminates the risk and uncertainty that many businesses face when dealing with commodities.

Why Do People Use Futures?

The success of risk management is what draws people to futures. For example, a farmer who wants to sell this season’s wheat crop to a baking company can guarantee their current price with a futures contract. In the event that the price of wheat falls before the harvest, the futures contract provides the farmer with predictable compensation for the crop.

A futures contract can also protect the buyer from risk. If the price of wheat were to rise from the time of negotiations to the time of delivery, it could cause a financial blow to the bakery. Having the futures contract fixes the bakery’s ingredient costs.

The only downside of having a futures contract is the potential loss if the market moved in the direction of your favor. The farmer could miss out on higher profits if the price of wheat increases, and the bakery could miss out on substantial savings if the price of wheat decreases.

Do Futures Go Beyond Commodities?

Futures can extend beyond basic commodities. Contracts can be traded based on non-physical benchmarks like stock market indexes, or financial assets like long-term Treasury bonds or foreign currencies. No matter what is being traded, the common ground is the ability to predict trends well into the future. Expectations can be locked in now to provide protection regardless of what happens.

The futures market might have a reputation of being risky, but a little bit of understanding can go a long way of reducing that risk. Even if you never choose to participate in the futures market, you should at least understand how they work, and how they impact the companies whose shares are owned by millions of investors.

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Important Futures Trading Disclaimer
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment. You must review customer account agreement prior to establishing an account.

Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial. Carefully consider the inherent risks of such an investment in light of your financial condition. Though proper education, tools, and practice are necessary, they do not guarantee profitable results.

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Slippage
Your broker may have a contractual agreement not to seek redress for slippage, it’s obligation to execute stop loss orders at the stop loss price or better, will not apply to limit and stop loss orders during hours when it is closed. This also does not include bad price spikes. Bad price spikes are removed from the price charts quickly to alleviate confusion.