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A Guide to Understanding Opportunities and Risks in Futures Trading

from The National Futures Association

How Prices Are Quoted

Futures prices are usually quoted the same way prices are quoted in the cash market; in dollars, cents, and sometimes fractions of a cent, per bushel, pound or ounce; in points and percentages of a point for financial instruments; and in terms of an index number, for stock index contracts. Be certain you understand the price quotation system for the particular futures contract you are considering.

Minimum Price Changes

Exchanges establish the minimum amount that the price can fluctuate upward or downward. This is known as the "tick." For example, each tick for grain is ¼¢ per bushel. On a 5,000 bushel futures contract, that’s $12.50. On a gold futures contract, the tick is 10¢ per ounce, which on a 100 ounce contract is $10. You’ll want to familiarize yourself with the minimum price fluctuation—the tick size—for whatever futures contracts you plan to trade. You’ll need to know how a price change of any given amount will affect the value of the contract.

Daily Price Limits

Exchanges establish daily price limits for trading in futures contracts. The limits are stated in terms of the previous day’s closing price plus or minus so many cents or dollars per trading unit. Once a futures price has increased by its daily limit, there can be no trading at any higher price until the next day of trading. Conversely, once a futures price has declined by its daily limit, there can be no trading at any lower price until the next day of trading. Thus, if the daily limit for a particular grain is currently 20¢ a bushel and the previous day’s settlement was $3, there can not be trading during the current day at any price below $2.80 or above $3.20. The price is allowed to increase or decrease by the limit amount each day.

For some contracts, daily price limits are eliminated during the month in which the contract expires. Because prices can become particularly volatile during the expiration month (also called the "delivery" or "spot" month), persons lacking experience in futures trading may wish to liquidate their positions prior to that time. Or, at the very least, trade cautiously and with an understanding of the risks that may be involved.

Daily price limits set by the exchanges are subject to change. They can be either increased or decreased. Because of daily price limits, there may be occasions when it is not possible to liquidate an existing futures position at will. In this event, possible alternative strategies should be discussed with a broker.

Position Limits

Although the average trader is unlikely to ever approach them, the exchanges and the CFTC establish limits on the maximum speculative position that any one person can have at one time in any one futures contract. The purpose is to prevent one buyer or seller from being able to exert undue influence on the price in either the establishment or liquidation of positions. Position limits are stated in number of contracts or total units of the commodity. The easiest way to obtain the types of information just discussed is from your broker or from the exchange where the contract is traded.

Next chapter: Understanding (and managing) the Risks of Futures Trading


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