Forex Vs Stocks Vs Futures

Trading Futures vs. Stocks: What'south the Difference?

March 24, 2022 v min read

five min read

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Key Takeaways

Trading futures is similar in some ways to trading stocks
Margin trading tin can magnify gains and losses in stocks and in futures
Different stock shares, futures contracts elapse and have other unique features

Stock trading versus futures trading: Each pose intriguing possibilities. Just although stocks and futures share some common ground, they differ in several ways that investors should sympathise before diving in.

Buy low, sell high, right? It applies to both stocks and futures. That'due south pretty straightforward. Simply with futures, in that location are a few unique wrinkles. Permit's expect at a few basics.

What Is a Share of Stock?

If you purchase shares of stock, you're purchasing partial buying of a visitor, with the verbal portion depending on the company's full number of stock shares issued. For case, an investor who buys 1,000 shares of a company that has 1 million shares outstanding owns 0.i% of the visitor.

Owning shares of stock confers voting rights on some visitor affairs and the right to attend the company'southward annual shareholder meeting. Your shares stand for buying of the company's avails and a right to benefit from its futurity earnings (typically reported on a per-share basis). Some companies may also pay investors a quarterly or annual dividend, which is a proportion of the company's funds distributed to shareholders.

What Is a Futures Contract?

A futures contract is a legally binding agreement to buy or sell a standardized nugget on a specific date or during a specific month. Futures contracts are "standardized," or effectively interchangeable, and spell out certain contract specifications, including:

The quality and quantity of a commodity
Unit pricing of the asset and minimum price fluctuation (tick size)
Date and geographic location for concrete "delivery" of the underlying asset (but bodily delivery rarely happens, as most contracts are liquidated before the delivery date)

Some of the well-nigh widely traded futures contracts are based on major bolt, such equally crude oil, corn, gold, and soybeans; others are based on stock indices, like the S&P 500, or interest rates—10-twelvemonth Treasuries, for example. It's also important to note that futures trading involves substantial risk and is non appropriate for all investors.

Futures and Stocks Both Merchandise on Exchanges, and You'd Probably Employ a Broker to Trade Either

Major stock exchanges, such as the Nasdaq and NYSE, provide a cardinal forum for buyers and sellers to gather. The same principle applies to futures, with virtually U.S. trading going through the Chicago-based CME Grouping. With both futures and stocks, nearly all trading is done electronically.

Exchanges also play an important part in ensuring conviction in markets. Many exchanges operate clearinghouses, which serve as backstops or "counterparties" for every merchandise.

To place a purchase order or sell social club in stocks or futures, nigh likely you'd open an business relationship with a broker (many futures brokers are known as futures commission merchants). With both stocks and futures, at that place are different types of orders investors should exist enlightened of.

Futures Contracts Expire; Shares of Stock Don't

This is an important distinction. An investor could, in theory, concur shares of a company forever, as long as the visitor remains publicly traded, although there are a number of reasons this may not happen—for example, if the company is acquired or if information technology converts into a private entity.

A futures contract, in contrast, has a fixed life. June 2022 crude oil futures (/CL), for example, elapse on a sure engagement based on the contract specifications. Well-nigh futures contracts aren't held to expiration. As a contract nears its expiration, many futures traders shut or "roll" their positions into a afterwards month, equally many firms do non permit physical commitment and will shut out the position prior to expiration.

Margin Can Be Used to Merchandise Both Futures and Stocks, merely There Are Key Differences

In the disinterestedness marketplace, buying on margin means borrowing money—using "leverage"—from a broker to purchase stock. Margin is effectively a loan from the brokerage house. Margin trading allows investors to buy more than stock than they ordinarily could, often with the aim of magnifying gains (although margin will besides magnify losses).

Under the Federal Reserve's Regulation T, or "Reg T," investors with margin accounts can infringe upward to fifty% of the purchase toll of securities that tin exist purchased on margin (also known as "initial margin"; some brokerages require a deposit greater than 50% of the buy price).

Margin works similarly in the futures market, but considering margin requirements are typically much smaller for futures, a trader can control a larger position value with relatively little money downward.

When trading futures, a trader puts downwards a practiced-faith deposit called the initial margin requirement, also known equally a functioning bond, which ensures each party (buyer and seller) can meet the obligations of the futures contract. Initial margin requirements vary by production and marketplace volatility and are typically a pocket-sized per centum of the notional value of the contract—frequently three% to 12%.

What Are Some Advantages and Disadvantages of Trading Futures Versus Stocks?

The futures market offers exposure to some of the globe's most important commodities and tin be a tool to help diversify or hedge a portfolio, or speculate on the underlying commodity.

Suppose yous hold oil company stocks that you want to keep for the long term, but you're concerned a brusque-term driblet in oil prices could crimp free energy company earnings. Through crude futures, you could have a "short" position that would produce a profit if oil prices did indeed fall, but yous would exist exposed to unlimited adventure on the upside should rough prices rise. Yous could place an gild to buy back that short position, and if the cost of crude oil is below the toll you lot originally sold the position at, whatever gain could aid starting time newspaper losses in free energy shares. Futures can also, through leverage, be practical to attempt to maximize capital letter efficiency.

A futures or stock position can also quickly turn confronting you, and heavy leverage could make matters worse.

Because margin magnifies both profits and losses, it's possible to lose more than the initial amount used to purchase the stock. If prices motion against a futures trader's position, it tin produce a margin telephone call, which means more funds must be added to the trader's business relationship immediately. If the trader doesn't supply sufficient funds in time, the trader'south futures position may be liquidated.

Margin calls can also happen in stock trading, so it'due south important to empathize the nuts of margin trading.

Bruce Blyth

Key Takeaways

Trading futures is like in some means to trading stocks
Margin trading can magnify gains and losses in stocks and in futures
Unlike stock shares, futures contracts expire and have other unique features

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