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