7 Key Terms Every Futures And Commodities Trader Should Know
Futures and commodities trading involve a specialized set of terms and concepacts essential for understanding market dynamics and making informed futures and commodities trading decisions. Below are key terms that every trader should be familiar with:
Futures contract:
A futures contract is a standardized agreement to buy or sell a specified quantity of a commodity or financial instrument at a predetermined price on a future date. These contracts are traded on futures exchanges and serve as a tool for hedging against price fluctuations or for speculative purposes.
Margin:
Margin refers to the initial deposit required by brokers from traders to cover losses from adverse price movements. It is a percentage of the contract’s total value that traders must maintain in their trading accounts. Margin requirements can vary based on market volatility and the trader’s risk profile.
Leverage:
Leverage allows traders to control a larger position in the market with a smaller amount of capital. It amplifies both profits and losses. For example, a leverage of 10:1 means that a trader can control $10,000 worth of contracts with just $1,000 in margin. While leverage can improve returns, it also increases risk.
Contract size:
The contract size specifies the quantity of the underlying asset that is traded in each futures contract. It varies depending on the commodity or financial instrument being traded. For instance, one crude oil futures contract typically represents 1,000 barrels of oil, while one gold futures contract represents 100 troy ounces of gold.
Settlement:
Settlement refers to the process of fulfilling the obligations of a futures contract. It can occur through physical delivery of the underlying asset (e.g., agricultural commodities) or cash settlement, where the difference between the contract price and market price is settled financially.
Open interest:
Open interest indicates the total number of outstanding futures contracts that have not been settled by an offsetting trade or delivery. It provides insights into market liquidity and trader sentiment. Rising open interest suggests increasing participation or new positions, while declining open interest may indicate liquidation or reduced interest in the contract.
Contango and backwardation:
Contango and backwardation are terms used to describe the relationship between futures contract prices and the spot price of the underlying asset. Contango occurs when futures prices are higher than the spot price, reflecting storage costs and other factors. Backwardation occurs when futures prices are lower than the spot price, often due to immediate demand or supply constraints.