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Futures definition

Futures explained

Futures are a type of derivative. These financial contracts see two parties enter into a binding agreement where assets are sold on a set date in the future at a set rate – irrespective of whether prices on the open market have risen and fallen.

Although this may not seem too attractive at first, futures are incredibly valuable for companies that need to purchase commodities at high volumes. For example, a burger chain can rest assured that they will be able to acquire the beef they require at a fixed price in the months and years to come – eliminating uncertainty from their business model. Futures are also beneficial for farmers and the firms responsible for producing the raw materials, as they will be guaranteed a set amount of revenue in exchange.

What can be traded using futures?

These contracts can be used for a plethora of underlying assets. As well as commodities including crude oil, coffee, wheat and natural gas, futures can be used for stocks, precious metals and currencies. Futures aren’t always used for shielding buyers and sellers from unpredictable price movements – for traders, they can also serve as a tool for speculating on whether prices are going to rise or fall in the future.

Futures: The downsides

It is worth noting that the businesses and investors who use futures do run the risk of spending considerably more when acquiring the underlying asset if prices fall unexpectedly.

There’s also an additional danger if a trader decides to enter into a futures contract on margin. This is where they post a deposit in order to fully control an agreement. Although this can substantially increase returns if prices go in the right direction, this can amplify losses dramatically too.

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