Two Way Oportunities
The below picture illustrates the beauty of futures trading, its 2 way opportunities. On an uptrend, picture on left, we enter the market with a buy new. Later the price went up, we liquidate with a sell order. The difference between the buy price and the sell price is our profit. This is very normal, we need to buy before we can sell.
On a downtrend, picture on the right, illustrates an opportunity when price is declining. As long as we have enough margin, we can enter the market with a sell new position. As soon as the price shows a reversal, of going up, we liquidate with a buy to offset our position. The difference will be our profit. This lies the uniqueness of futures trading, we can sell first, then buy later to offset.
Imagine that there is a bus (the price) in the market. The driver is blind. The driver will move according the volume of screams from the passengers. In an uptrend, there are more passengers with buy tickets, they need to exchange their buy tickets with a sell ticket to get off the bus, to get out of the market. So, the passengers with buy tickets will scream “UP!” as loud as possible, as many times as possible, until the driver (price) move upwards. Upon reaching the desired higher price area, the buy tickets were exchange for sell tickets and the passengers are off the bus, and out of the market.
Its directly opposite for sell tickets. Passengers need to exchange for a buy ticket at a lower price area, so they’ll scream “DOWN!”. When we do not hold any position or ticket, we are not affected where the blind driver goes.
A farmer producing sugarcane wants to sell his product at the best possible price, while a sugar factory wants to buy sugarcane at the lowest possible price. Both these examples are physical trades. While waiting for the sugarcane to harvest, both the farmer and factory are prone to price changes. In order to hedge, safeguard, against drastic price changes, the farmer will take a buy position in futures because he sells physical goods and the factory will take a sell position in the futures contract because the factory buys the physical goods.
For investors in shares, they can hedge their investments in Stock Index. When prices of shares take a dip, the investor will suffer losses if he/she decides to sell. But by taking a sell position in Stock Index, the investor is hedging his investment. How? Even though the share prices has dropped, which will also move the Stock Index down, the investor still owns the shares, although with lower value. When prices start to recover on the shares, the Stock Index will also increase. Thereby allowing the investor to liquidate his sell position and make some profits at a lower price before the Stock Index follow the rise of share prices. In effect, the loss in value of shares has been realised by the profits made in Stock Index which allows the investor to maintain his shares and enjoy his profits or purchase more shares at the lower price.
Importers and exporters also utilises futures trading as a hedging tool. The global trade is usually done in US$ (United States Dollars). An importer may purchase US dollars when the price is low, so that, when he needs to import products when the dollar goes up, he will not suffer losses.