If you’ve been following the budgeting guidelines we cover in our blog posts each week you should be well on your way to getting out of debt and having your personal finances under control. Once your personal finances are under control you should be working on some money that you can set aside to save or begin to invest. Investments are one of the best ways to grow your savings quickly because the old adage a penny saved is a penny earned is not exactly going to make you that much more wealthy than you are now. We need to invest those pennies in a way that helps them grow exponentially.
There are a plethora of fears associated with the stock market. How many times have we heard of people investing and getting on top only to bottom out the last second?
What Are Futures?
Futures are another option for people who really want to do their research and make money off of their good senses and not just risks or gambling. Commodity futures exchange is a marketplace used by people interested in buying or selling agricultural commodities.
This is specifically used in agriculture to reduce the risk on price changes for farmers. This system dates back all the way to ancient Rome where farmers reduced price volatility by creating systems for hedging.
Futures can be seen as paying for a contract early in order to lock in a price. For instance if you pay for a home security system the year before it is installed and you are promised a specific price you can expect that price no matter how the company does or what happens in the market.
It All Depends on The Market
This can be good or bad depending on whether the price goes up or down in the market. If the price goes up then you are saving money on your security system but if it goes down that you lose money.
This is the idea of buying hoping for things to raise in price and selling in the hopes of the commodity to lower in price.
Here in the United States Chicago is the center for agricultural commodity trade. This is where merchant or investors carry some of the risk from farmers and buy and sell.
Ultimately the exchange of futures is a price discovery system much like an auction where we find out where the “price is right”. The reason this works is because the public has access to information when they are making decisions.
This is great for farmers who may have seasonal risks such as weather and crop diseases. These can cause chaos to a farmers field but if he is able to make early transactions he doesn’t assume all of the risk.
Futures provides a way to stimulate agriculture in America.
How to Manage The Risk
So how can we manage the risk that we assume as entering buyers or sellers in the futures market?
First—The main way that a trader can manage risk is by being aware of what is going on with that commodity, not only domestically, but globally as well.
This has a huge impact on the economy and can raise or lower prices quickly. For instance a drought in Australia could quickly lead to wheat prices increasing as the supply of wheat decreases.
Second— Using a broker or working with a firm can be very beneficial in trading because it gives you the information and research you will need to know when to buy and sell. Doing all of the research on your own can be risky and will require some ups and downs.
Third— Joining a commodity pool can be the least risky way of trading as you join together with other investors and any losses are proportionated out. This also allows you to invest in multiple commodities.
Fourth— having a game plan is key if you want to be a good trader. This means that you should have stop orders so that you pull out when you want to.
It is important to get a skilled broker on your side with the commodity pool.
These are just some standard trading ideas that can help you illuminate some of your risk. The risks are still there as the model is about price discovery and must therefore be free from anything but supply and demand.
This means that an understanding of economic principles and the specific commodity you invest in can be complementary to your trading.
With these things said it is important to remember the risks inherent in the system. It is possible to lose more money than just the money you put into your account.
This is the reason that trading should be budgeted for and used as “risk capital” for trading.