How Commodity Trading Differs from Stock
Trading
There are major differences between trading stocks and trading
futures. While stories of fortunes made or lost overnight on the
futures markets are largely untrue, the futures trader, if using a
sound trading system, can
usually make more
money on the futures market and make it much faster. However, if
that trading system
is not sound the trader can have greater losses.
This is because futures contracts are highly leveraged. Margins
(the deposit required) on futures contracts are much less than for
stocks, as low as 3% on some futures contracts compared with up to
50% for stocks. As well, futures investors are not charged interest
on the difference between the margin and the full contract
value.
The margins for futures contracts act more as a performance bond or
good faith deposit whereas the margin for stocks is more of a
loan.
Although the margin on futures contracts is quite small, it rides
the full value of the underlying contract as that contract rises or
falls, thus providing the leverage mentioned earlier.
Commissions charged by futures brokerages are normally much less
than brokerage commissions for other investments.
Futures markets use the open outcry (auction type) method of
trading ensuring very public, fair, and efficient markets. Plus, it
is much harder to trade on inside information as so many variables
affect the markets. Also, futures markets are very liquid.
Transactions can be completed quickly, which lowers the risk of
adverse market moves.
If you own stocks you are an owner of the company. This allows you
to share in the company’s profits, and losses, through dividends,
and increases or decreases in the stock’s value. It also gives you
certain voting rights with the company. However, a company can go
bankrupt, leaving you holding worthless stock.
When you buy and sell futures you are only entering into a contract
and don’t really own anything. What you have is an agreement to buy
a commodity or financial instrument (wheat or Treasury Bonds for
example)
at a specified price at a certain date in the future.
The person on the other side of the transaction has agreed to sell
you that commodity or financial instrument at that specified price
by the specified date. If you sell a futures contract prior to that
date you have offset your position and have either a profit or loss
on the trade.
The stock you bought 3 years ago is the same stock you can buy
today. Futures contracts, on the other hand, have very limited
lives. They are traded in a regular series of contract months
referred to as delivery months.
Futures contracts have expiration dates after which no further
trading for that month can take place. The September corn contract
you traded last year is not the September corn contract you are
trading this year. In fact last September’s corn contract no longer
exists.
Many futures contract months of the same commodity trade
simultaneously on the market, sometimes even years into the future.
The current contract is called the front month and the other
contracts are called the back months. They are called back months
even though they are for future months.
For example, corn trades for the months of January, March, May,
July, September, November and December. Suppose today’s date is
August 4, 2000. The current contract month for corn would be
September 2000 and so is called the front month. The months of
November and December 2000, January 2001, March 2001, May 2001 and
July 2001 are back months even though they are in the future and
even flow into the next year.
(This may sound confusing but its not ...really)
All of these months can be traded at the same time although most of
the trading activity takes place in the front month.
When the current month expires the next contract month becomes the
front month and so on.
About the Author
Rob Hall is a successful futures trader, President & CEO of
his own investment firm, and international author. His books on
learning to trade futures markets are distributed through Sumas
International Sales Ltd. View them at
http://www.futuresopps.com/Comm.htm
Written by: Rob Hall
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