What Is a Futures Trade?

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When it comes to the financial markets, most people are familiar with stocks, bonds, mutual funds and exchange-traded funds. While these are the most commonly traded financial instruments, many other options exist outside of these limited markets. The futures market is one that is often overlooked and misunderstood by many traders. Trading futures is a way to branch out and diversify your portfolio from the basic financial markets.

Futures Contracts
At the heart of a futures trade is a futures contract. A futures contract is a type of agreement between two parties in relation to buying and selling a commodity. With a futures contract, a buyer agrees to purchase a certain amount of a commodity from a seller at a future date. The price per unit is also agreed upon for the future date. Once the date arrives, the holder of the contract will take delivery of the commodity involved in the contract.

What is Traded
Futures contracts can be created for any number of items. In many cases, futures contracts are used for agricultural commodities, such as soy, wheat, corn, barley and pork bellies. While this was the original use of futures contracts, many industries use them today. For instance, you could buy a futures contract on oil, natural gas, gold, silver or palladium. These contracts are also used in other financial markets such as the stock market or in the currency market.

Features
When you engage in a futures trade, the contract will have several features. One of the most important features to be aware of is the contract unit. You need to know exactly how many units of the commodity you are buying. For example, if you were setting up a futures contract for silver, you would need to specify exactly how many ounces are included in the contract. The smallest amount that the price of the contract can fluctuate by or "tick" is also important to know.

Hedging Risk
Futures contracts are primarily used to hedge risk. By using a futures contract, a seller can minimize the amount of fluctuation in price of a commodity. Commodities can fluctuate greatly in price from one week to the next. If you are a regular seller of a commodity, you want to know that the price you can get for a future batch will not be below a certain point. The futures trade allows you to enter into a contract with a buyer and agree to a price for a future date.