What Are Futures?

Whether you are dealing in orange juice, wheat, pork bellies, silver or gold, if you are investing in commodities, you are dealing in the futures market. The goal is to make money when that commodity either gains or loses in value. In essence, you are betting on the future of the commodity.

Based on the same concept as other investments ? buy low and sell high ? futures are an agreement to buy or sell a set amount of a commodity or financial instrument at a set price in the future. The price is agreed on by the buyer and seller and included in a contract. The investor is required to make only a small deposit to control a much greater amount of the commodity. The small deposit, typically around 10 percent, is called a margin payment.

Therefore, if you wish to control 100 ounces of gold, and gold on that day is worth $350 per ounce, or a total of $35,000, you could control the entire 100 ounces of gold by putting down a $3,500 margin payment. It the price of gold rises, you will be credited the difference, but if the price drops, you will be responsible for coming up with additional margin capital to control the 100 ounces of gold. In essence you are responsible for the entire $35,000 worth of gold.

The idea of controlling a much larger amount of goods, with a margin payment, makes futures both an exciting and a very risky investment.

An investment in the futures market, unlike the stock market, is not a long-term investment. Contracts run for a period of months, and the longer you hold the contract, the more margin calls you will be required to pay on the contract price. Therefore, you do not want to hold a commodity very long.

The trading of commodities is brisk, meaning you need to stay on top of the price constantly. A slight gain or loss can mean a lot of money. For example, if the price of gold goes up by $50 an ounce, based on the example above, you would make $5,000. However, a $50 an ounce drop would mean you would lose your $3,500 investment and be responsible for another $1,500.

In addition, there are some other subtleties to investing in futures:

If you hold a futures contract until it expires, you will own that commodity. Therefore, you will want to sell the contract well before the expiration date.

In the futures market, for every buyer there is a seller, meaning someone is essentially betting the price will rise and someone is betting it will drop.

Numerous factors affect the commodities market ranging from the political climate to international monetary rates to the weather in a region of the country or another part of the world.

Minimum account balances to begin futures trading vary, but they can be as low as $2,000. You will need to maintain a certain amount of money in the account to meet margin calls.

Financial advisors recommend that a futures investor has at least a net worth of $100,000 and does not exceed 10 percent of his or her net worth in futures investing.

It is important to do a lot of research before entering the future market. The best sources of information include:

The Chicago Board of Trade

The Chicago Mercantile Exchange

The New York Mercantile Exchange

Futures Magazine

The Commodities & Futures Trading Commission