Meaning of Future Market
Future market is a market where future contracts are purchased and sold by traders. It is simply referred to as auction market where participants come for sale as well as purchase of commodities and future contracts meant for delivery on a specified future date. The market offers a means of complimentary activities on hedging and speculation as future contracts assist users to make speculations on direction of financial instrument, security and commodity. Future contracts traded in market are of different kinds like stock index future, precious metal futures, commodity future, currency future and U.S Treasury futures. Nowadays, future markets are present in good numbers all across the world. Some of the prominent markets are: The New York Mercantile exchange, The Chicago board of exchange, UK future exchange, The London Metal exchange etc.
Concept of Future Market
Future markets are fully computerized at present where all trading take place in digital form. It is also termed as electronic trading. However, in past the market used to function with the help of traders who use to shout loud in trading pit due to which old system was also called as open outcry trading. Hand signals and face-to-face interaction were used for communication of essential information. Future market is regulated by agencies around the world who closely monitor their activities. In U.S., future markets are regulated by CFTC (Commodity Future Trading Commission) and regulator for United Kingdom is FCA (Financial Conduct Authority).
Advantages of Future Market
The advantages of future market are as described in points given below: –
- Open market for risk-tolerant investors: Future contract market serve as a useful mean for risk-taking investors in generating better returns. Investors with good knowledge and judgement skills can make money more quickly in future as compared to normal stock trading. In future market, price moves more faster than spot or cash market. In absence of future market, investors can’t be able to participate in market for buying and selling futures.
- Higher Liquidity: Future market are highly liquid in nature where huge number of futures are traded on daily basis. Market orders in these markets can be placed with quick pace because of the constant presence of both buyers and sellers. In addition to being highly liquid, many of the future market runs beyond traditional market hours i.e., 24 X 7 hours. All this enables trader to enter or exit market at any point of time whenever they wish.
- No involvement of time decay: Future market is free from time decay under which price of securities or commodities declines over time. The value of assets in case of options decline over a period of time which severely bring down the profit possibility for trader. Whereas in case of futures, trader do not need to worry about time decay.
- Simple pricing: The future market has simple pricing which is quite easy to understand for traders. It is not as difficult as Black-Scholes Model based option pricing. Pricing of future market is based on cost-of-carry model where future market are calculated via addition of cost of carrying to asset’s spot price.
- Low commission and execution cost: Future trade involves very low commission and are charged at the point of position closure. Total commission or brokerage value is as low as 0.5% of overall contract value. However, the level of service offered by broker also reflects the commission and execution cost. The commission amount in online trading can be as low as $5 per side and on other hand, it may even go up to $50 per trade in case of full-service brokers.
- More efficient and fair: Future markets are more efficient and fairer due to the difficulty of trading on insider information in such markets. The trading take place on market aggregates not lending themselves to insider trading. This way the future market is more efficient providing average investors with fairer shake.
Disadvantages of Future Market
Various disadvantages of future market are as follows: –
- No control over future events: Trading in future market suffers from a major drawback of unforeseen future events. There is no control over events that will take place in future point of time. The demand-supply equilibrium may be completely disrupted by unexpected weather conditions, natural disasters, political issues etc. which may cause great losses to traders.
- Expiration dates: There is a certain expiration date in case of future contract traded in future markets. With the expiration date approaching closer, the contracted prices of assets can become less attractive. Many times, because of this, a future contract may become worthless investment on expiry date.
- Issues in leveraging: Future market also faces issues in trading due to high leverage in market. The prices of securities fluctuate very frequently like going up or down on daily basis or even within minutes. Traders need to be very attentive and utilize the favorable price movements in timely manner.