Investing in the stock market can be simple enough for your average amateur investor. You buy stocks or shares in companies that you believe will increase in value and you sell stocks and share in those who you believe are in decline. You make money if the stock that you hold increases in price and you lose money in the price decreases. Simple enough right? Investing in stock futures is a whole different ball game and can intimidate your average investor. There are however advantages to investing in futures rather than simple stocks and shares and big money can be made. Read our beginners guide below to find out how to get started in stock futures.
What Are Stock Futures
A stock futures contract is an agreement between a buyer and seller to transfer a stock at some future date for an agreed price. While futures contracts can be applied to any type of asset they are often used for stocks and shares. Crude oil, crops, gold, bonds and foreign currency are other popular forms of futures. It is essentially a bet between 2 parties on the future value of a commodity and it is big business in the city. Futures were originally designed to allow producers of agricultural products to hedge their bets against fluctuating prices between producing their products and selling them. Nowadays investors bet on the likely impact of quarterly earnings reports on the companies share price or on the impact of a new product launch on its earnings. Similarly, investors bet on likely fluctuations on the price of oil or foreign currencies depending on world events. It’s a more complicated way to invest but the profits can be huge if you can accurately predict the movement in the value of an asset.
Single Stock Futures vs Stock Index Futures
A Single Stock Future doesn’t refer to an agreement over a single share in a company, instead, it refers to a contract involving any number of shares in a single company. So for example, if a buyer agreed to purchase 1,000 shares in Apple for an agreed price at an agreed date, that is considered a Single Stock Future. You can trade these futures on many stock indexes including Nasdaq and the S&P 500.
Stock Index Futures involves the movement of an entire market such as the Nasdaq Index of the FTSE100. You agree to buy an index at a specific date in the future at a set price. If the index price rises above this set price the investor makes a profit and if it falls below the agreed price, the seller reaps the reward.
A Global Game
One of the things that makes stock futures so interesting is their 24 hour a day nature. The movements of stock markets around the world including London, Frankfurt, China and Japan can have a big impact on the performance of stocks here in the US. For example, a fall in the value of the main stock market in China can suggest a fall in consumer demand in that country which in turn can have a negative impact on the performance of Apple’s share price. Have you ever woken up in the morning, switched on the news and seen a big fall in a share price of a particular stock even before the US markets have opened? That’s a result of the global nature of stock trading in general and stock futures in particular.
Asian stock markets have become very popular with US investors because of the growth they have shown in recent years as emerging economies. Some experts also believe you can predict the performance of the US market by paying attention to the Asian markets the day before. While this is not a sure-fire method, it is a good indicator of likely performance.
Buying and Selling Stock Futures
One of the key differences between traditional stock trading and stock future trading is that futures are traded on 24/7 basis while traditional stocks can only be bought and sold when the stock market is open. In fact, some of the most successful stock future traders make most of their profits outside traditional trading hours.
In order to start trading in stock futures, you first need to open up a “margin account” with the brokerage of your choice. Nowadays there are many online brokerages which are an easy way to get started. Alternatively, you can contact a traditional stockbroker and open up an account with them. When you are ready to get started you will place your first futures order. Either a “call” contract (you plan to buy a particular stock future contract) or a “put” contract (you plan to sell a particular stock future contract). Standard futures contracts revolve around groups of 100 shares of stock and you can expect to pay a margin fee of around 10-20%.
What Is A Margin Fee?
Buying stock futures on a margin means borrowing money from your broker to buy the contract. It is basically a loan from your broker. Buying stock futures on a margin allows you to “leverage” yourself and buy more stock than you’d normally be able to afford.
Let’s say you want to invest $1,000 in Facebook stock priced at $100 a share. You can either buy 10 shares for $1,000 or a future contract of 100 Facebook shares with a 10% margin for the same amount. Now if the shares increase by $10 you would make $100 by holding the shares or $1,000 via the stock future contract. Be aware however that the opposite holds as well. You can lose far more money via a margin call on a stock future than you would be holding the stock directly. You can make money fast using stock futures but you can also lose it just as quickly!
Always Consult An Expert
We strongly recommend amateur investors seek financial advice before they start investing in stock market futures. Like all investments, stock market futures offer both risk and rewards. Good profits can be made but losses are just as likely if you do not know what you are doing. Find a reputable broker to work with a take a training course to better prepare you for your first stock future trade.