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The Futures Trader – Participants In The Futures Trading Market

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Introduction

 

 

In the late 1800s, farmers from all over North America traveled to the shores of lake Michigan to sell their crops at the Chicago commodity markets.

However, it wasn’t uncommon for farmers to travel the long distance only to find that no one was interested in buying their harvest.

Without a buyer, the crop was worthless, and many dumped their grains into lake Michigan and returned home empty-handed.

If the futures market had existed, farmers could have secured buyers before ever traveling to the market.

In this lesson, we’ll discuss the purpose of the futures market, identify important futures traders, and define their roles.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.
Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Futures Participants

 

 

Let’s start by understanding a futures contract.

Essentially, its a legally binding agreement to buy or deliver a predefined quantity of a commodity or other financial product at a certain date for a specified price.

For example, a farmer who is a commodity producer might sell futures contracts to ensure a buyer for his product, which may be delivered in nine months. This contract ensures that the farmer has a buyer and a set price for the
commodity.

These commodity producers’ are our first group of futures market participants.

 

 

When producers’ like farmers sell a futures contract, it gives them the opportunity to lock in a certain price for their goods – but there may be a downside to securing a price in advance.

Producers may lose out on potential gains if the price of their commodity increases beyond the price specified on the contract.

 

 

Knowing¬† they have a buyer and a set price is often more important to producers’ than speculating on future price trends – which leads us to ours second group, the hedgers.

Hedgers are often the end users of commodities. Like the producers’, they also want to protect against price changes.

For example, one of the largest costs for airlines is fuel. Many airlines might use futures to protect against the rising cost of fuel.

Like producers’, hedgers don’t usually like to speculate on prices. They want predictability, so they buy futures contracts to lock in a purchase price.

 

 

Large money managers may also use the futures market to offset potential losses in their investment portfolios.

For example, suppose a money manager fears that stocks might fall. She could sell a futures contract on the S&P 500 index as a way to offset potential losses that come with a downswing.

 

 

Both hedgers and producers’ want to get the best price they can. However, producers’ and hedgers aren’t always buying and selling at the same time. This is why our third group, speculators, is so important.

Speculators stand ready to trade with producers’ and hedgers at any time. Speculators can be large trading and investing institutions or individual traders.

 

 

They don’t produce or use the underlying asset, but instead aim to profit from changing prices. Because of this, speculators provide liquidity for the futures market – or in essence, the ability to easily buy and sell a futures contract at a fair price.

When a producer comes to the market to sell his futures contract, he commonly sells them to a speculator.

Similarly, when a hedger comes to buy a contract, she commonly buys from a speculator.

The greater the liquidity, the easier it may be for producers’ and hedgers to buy and sell.

 

 

This is why its important to understand who participates in the futures market, because they determine supply and demand of the product, which in turn affect a commodity’s price.

 

Related image

 

Quick Recap

Futures Contracts

 

  • Essentially, its a legally binding agreement to buy or deliver a predefined quantity of a commodity or other financial product at a certain date for a specified price

 

There Are Three Main Types Of Futures Traders

 

1. Producers

2. Hedgers

3. Speculators

 

 

Producers

 

  • When producers’ like farmers sell a futures contract, it gives them the opportunity to lock in a certain price for their goods – but there may be a downside to securing a price in advance
  • Producers may lose out on potential gains if the price of their commodity increases beyond the price specified on the contract

 

Hedgers

 

  • Hedgers are often the end users of commodities. Like the producers’, they also want to protect against price changes
  • Like producers’, hedgers don’t usually like to speculate on prices. They want predictability, so they buy futures contracts to lock in a purchase price
  • Both hedgers and producers’ want to get the best price they can. However, producers’ and hedgers aren’t always buying and selling at the same time. This is why our third group, speculators, is so important

 

Speculators

 

  • Speculators stand ready to trade with producers’ and hedgers at any time. Speculators can be large trading and investing institutions or individual traders
  • They don’t produce or use the underlying asset, but instead aim to profit from changing prices. Because of this, speculators provide liquidity for the futures market – or in essence, the ability to easily buy and sell a futures contract at a fair price

 

Circulation Of Futures Contracts

 

  • When a producer comes to the market to sell his futures contract, he commonly sells them to a speculator
  • Similarly, when a hedger comes to buy a contract, she commonly buys from a speculator
  • The greater the liquidity, the easier it may be for producers’ and hedgers to buy and sell

 

 

 

 

 

And these are the types of futures traders that you will find in the futures market.

It’s important to know that each of traders have a very important role within the futures market – as without one, the market will lose its trademark liquidity and decrease the functionality of the market as a whole.

The type of trader that you may want to be may rest solely on your own agenda and investing/trading goals. If you physically have your own commodities, you may fall under the producers’ category (as these are mostly farmers or commodity sellers – and are the critical players that jump start the futures trading economy).

If you would like to buy certain commodities for their consistency and for stable income – you may be classified as a hedger (Note that hedgers range from individuals to financial institutions and like producers, they make trades to protect their capital).

If you want to “play the market” per se and trade futures for the advantage of quick and instant profits, you may fall under the category of speculators (These players are critical and provide the liquidity to the market – as without them, the market may just fall flat. These types of traders may be professional day traders, or investment firms – who often use complicated and advanced techniques to earn them quick revenue within a very short time span).

Futures trading, like all derivative day trading is extremely risky. This should only be used by advanced and sophisticated traders who have years of experience and expertise.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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