Commodities and futures are a complex, high-risk branch of financial speculation, best reserved for highly sophisticated and well-capitalized players. Amateurs lose a great deal of money to professionals in this market, and brokers make a great deal of money by connecting one group with the other. Unlike speculation in stocks, bonds and other securities, speculators can become financially liable for amounts greater than their initial investment in the futures contract. The other side of the coin is their ability to leverage small amounts of capital into large gains if the speculator is correct about market movements. The options market can serve to reduce this risk, but, once again, this is an extremely complex undertaking.
When you purchase a futures contract, you predict the future price of a commodity (corn, gold, oil) or investment (the dollar or other currency, the Dow Jones Industrial Average). You can be long, meaning you predict the price will rise beyond a certain point, or go short meaning you profit from a decline in the price. Transaction costs and brokers fees, of course, cut into your potential profit in either direction.
The speculative market for futures creates liquidity for commodities and currencies. A manufacturer who requires sugar, for example, may purchase a futures contract allowing it to purchase sugar in three months at a specific price. The cost of the contract will be a very small percentage of the cost of the actual commodity. If speculators (and other sugar users) bid up the price of sugar beyond that price, the manufacturer is assured of getting the sugar at an affordable price. If the market bids the price down, the manufacturer buys the lower priced sugar on the market and the contract expires unused. In either case, the manufacturer makes a small purchase to protect itself against potentially damaging price fluctuations. A similar situation would exist for exporters or importers who wish to protect themselves from unpredictable currency variations. Most speculators in futures do not ever contemplate taking delivery of the commodity or currency in which they speculate, however.
Next Section:Tangible Investments
Personal Finance: Chapter Home
Life in the USA Home Page.