Futures trading is often misconceived as a complex, high stakes and risky venture. This is far from the truth. The misconception springs from the lack of the proper financial know-how about the subject and a clear understanding of what it is for.
What is index futures trading?
Index or stock futures trading is the buying or selling of a set quantity and quality of a financial instrument, which will then be delivered and settled at a predetermined time in the future at a price set during the time of purchase. Institutional investors typically make use of stock index futures to hedge positions of the underlying stocks in their portfolio.
A futures contract therefore, is a type of investment instrument, in which two investors agree to negotiate on a set of financial instruments or physical commodities for delivery at some future date, usually three months, at a set price. If you invest on a index futures, you are agreeing to buy something that is not physically there yet at a fixed price. But participating in online futures trading does not necessarily mean that a buyer or a seller will be accountable for receiving or delivering huge inventories of physical goods.
Participants in the index futures market primarily enter into futures contracts to minimize risk or speculate rather than to exchange physical goods with a goal of earning a profit. As market prices are highly volatile and susceptible to economic movement, the futures market is a game of both chance and wit, therefore, definitely not for the risk averse.
Basically, index futures exchanges offer two venues for trading: the conventional floor-trading venue and online trading. Regardless of venue, trading is essentially the same in either format: Customers submit orders to be carried out by other traders who take equal but opposite positions, trading at costs which other customers buy or purchasing at prices which other customers sell. This matching of buyers and sellers occur in both floor and online trading.
The main difference is that in floor trading, orders are relayed to brokers in a trading pit, via phone calls from customers or through computers. Customer bids and offers are presented by brokers to other brokers standing in the pit, and matches are made. Results of the trade are relayed to customers, then sent to clearing house and brokerages, and prices are spread instantly throughout the world. The order is time-stamped at the opening and closing of the trade.
For online trading, customers send buy or sell orders directly from their computers to an electronic marketplace offered by the exchange. Brokers are no longer needed to submit and execute orders for the customers as brokerage approval to trade as well as notice of activity to brokerages are instantly carried out by the computer. Notice the absence of the brokers in online futures trading? The exchange online system notes all trading activity, and pinpoints matches of bids and offers. Trade information is then sent to the brokerage and clearing house, therefore prices are faster relayed to the public.