Points To Consider When Transitioning From Trading Stocks To Futures

Points To Consider When Transitioning From Trading Stocks To Futures

When it comes to investing, whether it is in stocks, options, or futures, hindsight is always 20/20. It’s easy for all of us to look at the many tables, charts, diagrams, spreadsheets and other documented material and say what we would have done if we had been in the market at that time. “I would have bought it here at this point and I would have sold it when it reached that point. The truth is that if it were that simple we would all be working the market everyday and making a fortune.

While for most newcomers trading in stocks can be quite tricky and sometimes even confusing, trading in futures is even more so. Knowing when to buy, buy more, or when to cut your losses and get out is not always easy to determine and one needs to invest a bit of their valuable time to learn the fundamentals of futures trading before they invest their hard earned money.

One needs to know what their choices are and understand enough of how the market runs to be able to distinguish when something is off and when you’re looking at a normal fluctuation. There will be lots of financial experts that will give you advice and it will be up to you to distinguish when someone is trying to pull you towards their own personal agenda and when they really do have information that is valuable to you. It will be up to you to glean from all of the chatter what material will be valuable at that particular time.

Whether you’re getting your financial advice from a professional analyst, accountant, advisor or just a coworker or a friend a basic rule of thumb is to make sure that you fully understand what anyone who is giving you advice is really saying. Ric Edelman in his book ‘The Truth About Money,’ had this to say about choosing who to listen to,

Some advisors try to impress (or intimidate) clients by talking too fast or using technical jargon ordinary consumers can’t comprehend. No matter what anyone tells you, the field of personal finance is not all that complicated. If you don’t understand it, don’t do it.

So, as you’re trying to learn everything you can about the futures market, you need to make sure that you’re not getting your advice from someone who is talking above your head. If they can’t package the information in a way that is easy for the average layman to digest, you may not want to deal with such a person.

photodune-1438556-stocks-xsDifferences Between Stocks and Futures

Once you’ve decided on a financial adviser that you can trust there are basic fundamental understandings that most people who transition from stocks to futures needs to comprehend. There are some very distinct differences between the two, which should have a bearing on the way you make your investment decisions. Unlike with the stock market where with each purchase of a stock you are buying an actual asset, with purchasing futures you are not buying something tangible but merely a right to purchase it at a set price in the future. This singular difference can affect your business trading style in a number of ways.

While you may have traded in stocks before the whole concept was to buy a partial ownership in the business. But with futures you are in effect entering into a binding, legal contract that gives you the right to purchase that particular commodity at a predetermined price on or before a specific date. You are actually lining up your future investments instead. For example, if you have decided to invest in wheat next May, you can set the price of that commodity ahead of time so that when your contract matures, regardless of what the existing price of wheat happens to be you will be locked in at the predetermined price. At that time you will either take “delivery” of the asset and you will become part owner or you’ll sell you contract before the expiration date and collect your profit. Financial experts at the Street Directory can explain this point very clearly,

With stocks, you will pay for the stock at the time of your purchase plus broker commissions. When buying a futures contract, you are simply entering the buy side of a contract and no money is paid other than commissions to your broker.

Other than for commissions when you buy futures no real money exchanges hands until the contract expires.

Commodities and CashYour Down Payment

Just as if you were purchasing a home, you and the seller will come to an agreement on a specified price for the house. Once you both concur you enter a contractual obligation to purchase that home but the real money does not exchange hands until the closing. And just like when purchasing a house, you are expected to put forth a down payment to show your good faith in making that purchase. When you invest in futures, this “down payment” or “good faith” payment is called a margin.

Each futures commodity has a different margin and your broker will be able to tell you the exact cost of each one for your investment choices. You can look at this as a protection against losses. If the actual value of the commodity that you choose was to drop and you are buying the contract, then your contract will have lost value. Investopedia points this out very simply,

In the futures market, margin refers to the initial deposit of “good faith” made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any day-to-day losses.

This concept is very different from a stock market view so for those people who are looking to transition over and widen out their investment opportunities by trading futures, it is essential that they understand they will be experiencing a very different learning curve. Your approach to the market and the end game will have some major differences that one must grasp. Without that grasp, your entire financial portfolio could be at risk.

Whether you’re looking to trade in stocks, options, futures or anything else. It is more important than ever that you learn the game rules before you begin. This way you can walk into the market with your eyes open and reduce your exposure to losses in the process.

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