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Trading Basics Part 3: What are Futures and Commodities?

Cash marketIn part one of our trading basics series, we discussed that stocks represent minute ownership in companies. In part two, we reviewed what an index is, and the different types. Now we’re going to cover what futures and commodities are.

What are commodities?

Generally speaking, a commodity is a class of goods used in the production of other end products. Examples include energy (crude oil, natural gas, gasoline, jet fuel, etc.), agricultural (such as corn, soybeans, wheat, rice, coffee, cocoa, sugar, cotton, etc.), livestock (lean hogs, pork bellies, live cattle, etc.) and metals (gold, silver, copper, platinum, etc.).

What are futures?

A futures contract is a contractual agreement, made with and through the exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price in the future, before contract expiration. Futures contracts detail the quality & quantity of the underlying asset as a means of standardizing trading. There is some speculation that rice futures may have been traded in China some 6,000 years ago, so this is hardly a new concept.

Trading futures & commodities

Here in the U.S., the formal trading of commodities has been conducted since 1848. The first actual futures contracts were traded in 1865 on the Chicago Board of Trade (CBOT), which was established in 1848. In 1919, the Chicago Butter and Egg Board became the Chicago Mercantile Exchange (CME). Since 1961, futures contracts have been traded at the CME on everything from frozen, stored meats, frozen pork bellies and live cattle to Eurodollar futures. Initially, farmers would use the futures exchanges to hedge for growth or weather phenomenon that could influence their crop yields and profits at later dates.

Some futures contracts call for physical delivery of the asset, called EFP, or Exchange for Physical. This is something you might want if you were trading in unleaded fuel, for example. Other futures contracts are settled in cash. Obviously, because we trade the E-mini S&P futures, all of our transactions are settled in cash and they’re no more complicated than trading a stock. There is no actual contract other than the brokerage agreement you have with your broker, and we do not have to worry about a future delivery.

Want to learn even more? Check out our Website at www.LeadingEdgeTrading.com to discover what it takes to trade like a pro.

Posted by Ford Saeks on November 3, 2014 in Trading Basics.

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