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Article #90: Stocks and Futures - What is the difference?

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Are you new to trading? Perhaps you service, like interest rates, from
wonder what the difference is between producers.
trading Stocks and trading Futures. Often To buy stocks, you only need enough money
when I meet someone new who inquires as in your account to purchase the stock
to what I do, I get a response of outright plus commissions. Once you make
"that's like trading stocks, isn't it?" the purchase, the money is removed
In some ways they are similar, but only immediately to make the purchase. With
minutely so. So let's consider some of trading futures, since you are not
the major differences between the two. actually purchasing anything but simply
Most individuals have likely traded entering a contract to do so at a later
stocks at one time or another. Usually, time (which you will exit prior to avoid
it is to buy in order to 'own' a delivery), the broker will require a
percentage of a particular company or certain amount of margin (good faith
to liquidate such partial ownership. They deposit to cover any possible losses)
pick up a phone to call a broker or go in what is called a 'margin account'.
online to purchase or sell. The order is Each commodity has a different minimum
facilitated through an 'exchange', such margin requirement depending on several
as the New York Stock Exchange for factors. Your broker may use the exchange
example. calculated margin or require a
Buying and selling Futures is similar in different margin of their own. If the
this respect. You can call a broker or value of the commodity were to decrease
go online to buy or sell Futures and you are on the buy side of the
contracts. The order is then contract, then your contract has lost
facilitated througha commodity exchange, value and your broker will notify you
such as the Chicago Merchatile Exchange if your unrealized losses exceeds have
for example. Yet while buying a stock gone beyond your minimum margin
gives you part ownership in a company or requirement. This is called a 'margin
portfolio of companies (as in a fund), call'. Naturally you would want to have
buying a Futures contract does not give more capital than simply the margin
you ownership of a commodity or amount when trading futures to avoid
product. Rather, you are simply these broker calls. The broker has the
entering into a contract to purchase the right (and likely will) liquidate your
underlying commodity at a certain price position if you are getting too close
at a future time, noted by the contract. to not having enough to cover the losses
For example, buying one May Wheat at in order to protect themselves.
3.00 simply creates a contract between With buying stocks outright, there is no
you and the seller (whom you need not potential for a margin call. You simply
know as this is taken care of via the own the stock outright. So perhaps you
exchange) that come May you will take may be wondering why anyone would
delivery of 5000 bushels of Wheat at $3 bother buying futures contracts rather
per bushel, regardless of what the price than stocks. The major answer is:
of Wheat at market happens to be come LEVERAGE.
May. As a speculator simply trading to Leverage gives the trader the ability to
make a profit from trading itself and control a large amount of money (or
with no interest in actually taking commodity worth a lot of money) with very
delivery of product, you will simply sell little money. For example, if Live
your contract prior to delivery at the Cattle futures requires a minimum margin
going market price and the difference of $800 to trade a single contract, and
between your buy price and sell price is a single contract represents 40,000 lbs
either your profit or loss. at the current market price of say 75,
When you buy a stock, you are part owner you would be controlling $30,000 worth
of a company. When you buy a Futures for a leverage of over 35:1. This is
contract, you simply are entering a appealing to many traders and justifies
contract. With stocks, you will pay for the risk. What is that risk? Just as
the stock at the time of your purchase leverage can work in your favor, it can
plus broker commissions. When buying a work against you at the very same
futures contract, you are simply ratio. Known as a 'two-edged sword'.
entering the buy side of a contract and You can increase the leverage of trading
no monies is paid other than stocks if you trade with a margin
commissions to your broker. account. This usually allows you to
Stock exchanges and commodity exchanges purchase stocks on margin at the usual
are both membership organizations rate of 50%. So for every dollar you have
established to act as middlemen between you can purchase $2 worth of stock. The
the buys and sells of all types of leverage is 2:1. How this works is that
traders, from business entities to the the broker is actually 'lending' you the
individual small trader. The stock other 50%. Of course by purchasing
exchange act to bring capital from stock with margin you can lose more than
investors to the businesses that need you have due to the leverage. And in
that capital. They facilitate the this case you can end up getting a
transfer of property rights (ownership in 'margin call' from your broker if your
the various companies offering stock losses too much value. But
stock).The commodity exchange act to trading stocks comes no where close to
bring people willing to assume risk for the kind of leverage you get trading
the opportunity to make a substantial Futures.
amount of money for taking such risk. When you look at these two trading
This helps transfer the price risk vehicles, the bottom line comes to
associated with ownership of various MARGIN and LEVERAGE.
commodities, such as Soybeans, or a






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