Traditional stock market investing is the most familiar form of investment and has been the main stream of financial opportunity for decades. However, stocks are just the foundation for a whole other set of investment opportunities for those who wish to make money. One of the biggest opportunities for serious return on investment lies in the derivative markets. These are side bets on the way stock’s will perform and commodity prices will go. Hence, the term futures investing.
A lot of people would rather bet on the direction a price will fluctuate and invest on that, rather than actually investing in the stock itself. This is the futures market. The terminology varies between stocks, animals, crops and metals, but the future value of those prices is generally what we call the futures market.
Futures Investing Analogy
Perhaps the best way to explain futures investing is with an analogy. Suppose there is a hatchery. The hatchery can produce 1,000,000 eggs in a few months and there is someone who will be able to buy the entire 1,000,000 eggs. However, the hatchery cares about the price of eggs today. Currently, it may be high, but in a few months from now it might be low. Of course, they don’t want to lose money if they sell it in a few months if the the price is lower than it is today. They could hope its higher, but they are in the egg selling business, not the speculation business. So, they enter into a futures contract with an investor.
In the contract they are going to set a price today, say for an amount of $100,000. In the future, the supplier will be paid on the delivery of the eggs. Perhaps in a few months, but an actual day will be set in the contract. Basically they have set the price now to gurantee that they will get paid $100,000. Of course, since the price has been set in advance there is usually a premium contract fee, as the seller is betting against the buyer.
How Do You Make Money?
Let’s assume it is time for the supplier to deliver the yield of eggs. If the value of the eggs is $200,000, then the investor has made a huge profit when the batch of eggs goes to market to sell. Remember, he gets the profit from the sale of the eggs. But the hatchery owner still made a profit from selling the eggs on contract. Granted, he would have made twice as much if didn’t sign the contract and sold them at the market price. But he’s a hatchery owner, not a gambler. And since he doesn’t know what the price will be like in the future, he signs the contract to guarantee at least some profit.
But let’s say the value of those eggs is only $50,000 at the time of delivery. For the hatchery, it doesn’t matter. They still get to sell them for $100,000 because of the contract. The seller has a legal obligation to buy them at this price. However, he can only sell them for half that, so he loses $50,000. Ouch! But the seller does not actually receive the eggs. You might imagine they sit in his garage and he has to sell them to recover some of his $100,000. But it does not work that way. He will never actually see the eggs. He just guarantees that the hatchery gets paid and can make more if the price of eggs goes up.
That’s Futures Investing!
The futures market is really that simple. However, futures investing and commodities require a lot of research and projection that will take a lot of time. Hours are spent reading and deciphering market reports, production yields and inflationary costs for production and consumption. This is why some traders would rather look at the futures market, rather than traditional stock investment, because it will tell them what market experts think the price of commodities will be – giving them a better idea of how the market will react to events in the future and investors can make their moves off of that.