Guide to Future Markets: a simpler explanation

stocks rise on asian futures markets

Guide to Future Markets: a simpler explanation

2019-05-02 By: ChristopherRay

Futures Markets are derivative contracts that negotiate the purchase and sale of products for future settlement.

It is a contract widely used for commodities (such as agricultural products), as it offers security to farmers in the face of price fluctuations and market demands.

For this reason, it is considered a hedge strategy, a concept that we explain in the article Hedge: what it is and how to use this instrument when investing, but it can also be used in leverage or speculation operations.

You may also be interested in our Comprehensive Commodity Guide.

But futures markets do not only apply to agricultural and livestock products. It is also possible to trade indices and currencies, for example.

To better understand this concept and how to invest in future markets, read on. In this article, you will learn:

  • What is the Futures Market
  • Type of Futures Market Contracts
  • What is the possible yield of the Futures Market
  • Futures Market Taxes and Taxation
  • Start investing with XP

What is the future market

futures markets photo

Futures market is an environment for negotiating the purchase and sale of assets with settlement at a future date.

Futures markets are negotiations for buying and selling assets for future maturity.

In other words: you set a price to buy or sell a certain product, but speculatively for a date in the future.

Thus, when you reach maturity, you will receive the earnings (or not) from the difference in these prices. It is worth mentioning that the daily adjustment occurs daily, where you will receive or pay adjustment according to the price variation.

Trading futures contracts is a hedge strategy. And hedging would be a maneuver to ensure the prices of products that may suffer from fluctuations in supply and demand in the market.

Depending on the strategy adopted, you assume a position purchased to win the high or sold for profit in the fall. Understand:

whoever is buying will profit if the prices of traded products rise;

who is in the position sold will profit in a price drop situation of these same products.

What is the purpose of future markets

man paint future graph

Futures market contracts protect companies and investors from price fluctuations and demand for products such as commodities, indices, the dollar, among others.

Thus, instead of buying and selling shares on the spot market, you negotiate futures contracts, which will be executed at a future date, according to the market conditions at that time.

Thus, depending on the daily results of the period between the negotiation of the contract and its maturity, you can obtain profit or loss on the operation.

Trading on futures contracts can minimize risks or maximize profits.

We will understand better how this is possible, in the following example.

In addition, the future market also aims to:

  • Speculation: different from the forward market, which we will understand later, the future market has prices readjusted every second. Thus, you can speculate the increase or decrease in the price of a product, buy the contract and sell it on the same day or the next day, taking advantage of the price variation that happened automatically. If you settle the contract on the same day, you will be doing a day trade on the futures market.
  • Arbitration: arbitration can be carried out by experienced investors who wish to mitigate the risks in any transaction. In this way, they negotiate contracts in the futures market that are in a financial position similar to their other operation, protecting the investor.

Understand the future market

Let’s work with the corn product, for example.

For this, we want to introduce Pedro, a corn producer who owns a farm with the potential to harvest 100,000 bags per harvest.

The sack of corn at the time when Pedro consults the market (6 months before harvest), is costing R $ 48.00, a high value compared to previous months.

So, to prevent this value from falling at the time of the harvest, Pedro decides to sell contracts on the future market. He sells 100,000 bags, for R $ 48.00 a bag. Now he takes the position sold.

Six months later, Pedro finishes harvesting the corn and goes to the market in his city to sell. The market buys the 100 thousand bags for the price of R $ 42.00, market value at the time of sale.

What happened here? Peter lost money? No: on the stock exchange, his futures contract generated profit, since Pedro sold for R $ 48.00 and the purchase price was R $ 42.00.

With the operation, he earned R $ 600,000.00, exactly the same amount that Pedro lost in the physical sale of corn in the market.

What is the difference between forward and future markets?

The forward market is also a purchase and sale negotiation at a future date, but it has an important difference: in this case, the parties assume their position and negotiated value until the contract is settled.

Thus, it is not possible to operate day trade by buying, for example, a future market contract and reselling hours later, taking advantage of the price fluctuation, which is automatically adjusted.

Future market risks

Although the futures market is a strategy used for hedging, investing in this type of contract is a risky transaction, even though, as we saw in the example, the futures market can reduce or eliminate losses caused by price fluctuations.

Thus, it is a recommended investment for investors with a bold profile.

The main risk is in leverage, which can cause the investor to lose control over operations and invest money that he does not have.

This is because, if you buy a high contract and it falls a lot, the investor can lose all the money invested.

Therefore, invest in the futures market only when you have sufficient knowledge for a correct analysis of the indicators, in addition to excellent emotional and financial control.

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