What is futures trading?

In order to understand futures trading we need to go back in time to where it all began, for this very modern trading method is actually over 300 years old.
In seventeenth century Japan the main currency of the day was rice; the farmers grew it and sold it for coin that enabled them buy seed and labour to prepare and grow the next harvest.The Samurai were paid in rice and they traded it for hard coinage so that they could buy their horses and finery that befitted their status in society.This exchange of rice & coin all took place at the Dojima Rice Exchange in Osaka. The Exchange soon developed into a warehouse system that allowed the rice farmers to negotiate price contracts for future rice deliveries at a set price whether the next harvest was good or bad. Before long, traders and speculators began to trade these future rice contracts between themselves and futures trading was born.
A wealthy farmer called Munehisa Homma was also a trader in these future contracts, and he realised that the probability of a good rice harvest or a poor one would directly influence the emotional decisions of other traders and speculators dealing in the futures contracts. In an effort to factor this in to the intrinsic value of the rice itself, he devised a charting system that used candlesticks as a graphical way of incorporating all the influences affecting the rice prices at any given time to try & predict the likely future movement of the contract prices.

Candlestick charting today has evolved into a sophisticated analysis tool is probably the most widely used system of technical analysis in all aspects of financial trading – stocks & shares, Forex, futures,options etc – and it is all down to Munehisa Homma and his 17th century candlesticks.

Futures trading today.

Today, futures contracts can be traded for almost anything, but it is mostly agricultural commodities – rice, wheat, potatoes, cotton, livestock etc – and minerals & metals, including diamonds, emeralds, oil, gas, gold, copper, & so on that dominate futures trading.

So who trades these futures contracts? Firstly, there are the people who produce the goods to sell and the people who buy it from them; it could be a wheat farmer selling his corn to a miller to make flour. These traders are known as hedgers, and they trade futures contracts to protect themselves from future price fluctuations in their commodity, in our example, the wheat that the farmer is growing. If our farmer thinks the price of his wheat will go down by harvest time, he can hedge his investment by selling a futures contract in his corn. Come the harvest, if the price of wheat has gone down our farmer can close his contract by buying it back at a lower price than he sold it for, the profit from this covers his losses he incurs actually producing the wheat.
On the other hand, there are the traders who never produce the commodity and never take delivery of it. They just trade the contracts, closing their trades before the expiry date that all futures contracts carry. These folks are known as speculators, and they trade futures as they would shares or Forex; buy low, sell high & vice versa.