The origins of today's futures market lies in the agriculture

markets of the 19th century. At that time, farmers began

selling contracts to deliver agricultural products at a later

date. This was done to anticipate market needs and stabilize

supply and demand during off seasons.

The current futures market includes much more than agricultural

products. It is a worldwide market for all sorts of commodities

including manufactured goods, agricultural products, and

financial instruments such as currencies and treasury bonds. A

futures contract states what price will be paid for a product

at a specified delivery date.

When the futures market is played by speculators, the actual

goods are not important and there is no expectation of

delivery. Rather, it is the futures contract itself that is

traded as the value of that contract changes daily according

the market value of the commodity.

In every futures contract there is a buyer and a seller. The

seller takes the short position and the buyer takes the long

position. The futures contract specifies a buying price, a

quantity and a delivery date. For example: A farmer agrees to

deliver 1000 bushels of wheat to a baker at a price of $5.00 a

bushel. If the daily price of wheat futures falls to $4.00 a

bushel, the farmer's account is credited with $1000 ($5.00 -

$4.00 X 1000 bushels) and the baker's account is debited by the

same amount. Futures accounts are settled every day.

At the end of the contract period, the contract is settled. If

the price of wheat futures is still at $4.00 the farmer will

have made $1000 on the futures contract and the baker will have

lost the same amount. However, the baker now buys wheat on the

open market at $4.00 a bushel - $1000 less than the original

contract, so the amount he lost on the futures contract is made

up by the cheaper cost of wheat. Similarly, the farmer must sell

his wheat on the open market for $4.00 a bushel, less than what

he anticipated when entering the futures contract, but the

profit generated by the futures contract makes up the

difference.

The baker, however, is still in effect buying the wheat at

$5.00 a bushel, and if he hadn't entered into a futures

contract he would have been able to buy wheat at $4.00 a

bushel. He protected himself against rising prices but he loses

if the market price drops.

Speculators hope to profit by the daily fluctuations in the

futures market by buying long (from the buyer) if they expect

prices to rise or by buying short (from the seller) if they

expect prices to fall.

FOREX

The foreign exchange market (FOREX) has several advantages over

the futures market. FOREX is a more liquid market – as the

largest financial market in the world it dwarfs the futures

market in daily exchanges. This means that stop orders can be

executed more easily and with less slippage in the FOREX.

The FOREX is open 24 hours a day, 5 days a week. Most futures

exchanges are open 7 hours a day. This makes FOREX more liquid

and allows FOREX traders to take advantage of trading

opportunities as they arise rather than waiting for the market

to open.

FOREX transactions are commission-free. Brokers earn money by

setting a spread – the difference between what a currency can

be bought at and what it can be sold at. In contrast, traders

must pay a commission or brokerage fee for each futures

transaction they enter into.

Because of the high volume of trading FOREX transactions are

almost instantly executed. This minimizes slippage and

increases price certainty. Brokers in the futures market often

quote prices reflecting the last trade – not necessarily the

price of your transaction.

The FOREX is less risky than the futures market because of

built-in safeguards in the trading system. Debits in futures

are always a possiblility because of market gap and slippage.