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A Guide to Understanding Opportunities and Risks in Futures Trading

from The National Futures Association

What to Look For in a Futures Contract

No matter what type of investment you are considering, begin by obtaining as much information as possible about that particular investment. The more you know in advance, the less likely there will be surprises later on. Moreover, even among futures contracts, there are important differences which—because they can affect your investment results—should be taken into account in making your investment decisions. Specifically, be certain you understand such things as:

The Contract Unit

Futures contracts specify such things as the unit of trading and contract size (such as 5,000 bushels of grain, 40,000 pounds of livestock, or 100 troy ounces of gold). Foreign currency futures specify the number of marks, francs or pesos. U.S. Treasury obligation futures are in terms of instruments having a stated face value (such as $100,000 or $1 million) at maturity. Stock index futures contracts that call for cash settlement rather than delivery are based on a given index number times a specified dollar multiple. Whatever the yardstick, it’s important to know precisely what it is you would be buying or selling, and the quantity you would be buying or selling.

Order Placement

Nothing is more important in futures trading than clearly communicating with your brokerage firm about what you want to buy or sell, when you want to buy or sell, and any other conditions or limitations you may want to attach to your order. For example, if you want to buy or sell immediately at the best available price, whatever that happens to be, this is known simply as a "market" order. But there are many other types of orders that give the broker specific instructions about when and/ or at what price to execute a purchase or sale. Your order instructions can specify not only when and at what price you are willing to establish a futures position but also include instructions about when and at what price, if possible, you want to liquidate the position. You also need to let the broker know whether you intend for an order to be a "day" order (valid for that day only) or an "open" order (one that remains in effect until such time as it can be executed according to your instructions).

Ask the brokerage firm you’re dealing with whether it can provide you with a written glossary of the various types of orders it and the exchanges can accept. Some firms offer recordkeeping books and online resources that can be handy for tracking your orders, executions, and open positions. Finally, be sure you have a full understanding of your firm’s order entry procedures.

Next chapter: How Prices Are Quoted

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