The main selling point of futures contract trading is that it provides traders with the opportunity to gain high profits quickly without having to foot the bill for overhead costs(click for more info). Singapore ranks highest in the Asia Pacific regarding speculative trading, even edging out Japan.
However, this also means risks associated with futures trading in Singapore. Are you aware of what they are? If not, keep reading below.
What are Futures Contracts?
A futures contract is an agreement where someone agrees to sell something at a specific price on a pre-set date. This other party mostly takes on the role of being your counterparty, i.e. someone who will buy from/sell to you if you expect that your position will be profitable upon termination.
In Singapore, futures contracts are primarily traded in derivatives; traders do not own underlying assets. Instead, they try to gain an edge on their trading by speculating whether the price of these assets will increase or decrease between then and when the contract expires (by buying more of it if they think that prices will rise; selling off some if they think prices will fall)
On top of this, most contracts also have a margin requirement. It means you must make good on any losses before you can terminate your position. It is usually achieved through depositing cash (with which you can buy/sell), but there are other ways like putting up securities as collateral.
What is the open interest?
This measures how many contracts are being traded at any time by calculating the total number of unique positions that have not yet been closed. Suppose Singapore has 100,000 open positions in a contract expiring in three months, and another 1,000 opened up within that period.Â
You can say that the open interest for this contract is 101 000 (101,000 + 1,000).
The higher this figure is, the more liquid the market – i.e. it tells us how trading there will be affected if people suddenly want to close out their positions altogether, whether they’ll be able to get out quickly or not.
How Futures Trading Affects Short Term Price Volatility
In the simplest terms, if many people have a position on whether prices will go up or down in a certain period, then futures trading can be used to profit from price volatility (i.e. short-term fluctuation in prices).
Let’s say that there is intense sell pressure: This means that many traders who think that prices will fall are trying to close their positions by selling off whatever assets they’re holding. There is more supply than demand for these assets (sellers vs buyers). They can only find willing buyers at lower and lower prices.
On the flip side, let’s say you think that according to all known information about an underlying asset, it is likely to increase in value over the next three months, i.e. you feel there is intense buy pressure. You would try to profit by ‘going long’, i.e. opening up a futures contract and buying at lower prices and selling at higher ones (when your contract expires).
So what happens if the prices go down? Well, buyers lose money on the amount they paid for the assets while sellers earn back more than they paid because of excess demand.
What Are The Risks Of Futures Trading?
The main risk is that most futures contracts need to be closed before expiration. If you hold a position and the market moves against you, there may not be time for you to break even on it. It is why it’s essential only to enter a trade if you have a strong feeling that the market will move in your favor.
After all, it doesn’t matter how much you know about whether prices go up or down in general if your strategies turn out to be wrong more often than not! Remember, don’t ever invest money you cannot afford to lose. There is always a chance of losing more than what you’ve put in because an investment is volatile by nature. In other words, futures trading involves risk.
