What are stock futures and why are they important to watch?

The range of futures contracts available to traders is extensive, covering asset classes beyond stocks and including commodity futures, currency futures and interest rate futures. When you hear the word “futures,” though, people are often talking about stock futures, and that’s what this article will focus on.

Keep reading to learn exactly what stock futures are, how to trade them and why they’re an important market indicator.

What are stock futures?

Stock futures are financial contracts that allow investors to buy or sell a stock at a predetermined price on a specific future date. This essentially lets investors lock in prices today for transactions yet to be made.

Think of a stock future like a bet. When betting on a sports team, you can bet either that the team will win or that the team will lose. A futures contract is similar. You can bet on the stock’s success (that its share price will increase) or on its failure (that its share price will decrease).

There are several types of stock futures to invest in: You can buy a futures contract on an index like the S&P 500, for example, or on an individual stock.

How do stock futures work?

Futures contract buyers are required to fulfill the terms of the contract. Here’s how it works: Let’s say you want to buy a stock future on ABC stock for $200 per share six months from now. If the price of ABC shares increases to $250, you will have made a profit of $50 per share.

If, however, ABC shares drop to $150, you will have lost $50. This risk is why stock futures can be so tricky. When you own a regular stock, your losses aren’t set in stone until you sell. For example, if you buy a share of ABC at $200 and the price drops to $150, your losses aren’t locked in unless you sell, and you can always wait to sell with the hope that the share price will rebound.

With futures trading, though, you’re obligated to complete the terms of the futures contract. Under the terms of a futures contract, the buyer is obligated to buy the stock at a certain time, while the seller is obligated to sell. Both obligations are legally binding, which is another reason investors should practice caution when pursuing futures contracts.

How do you trade stock futures?

To start trading stock futures, you’ll need to open a brokerage account with a firm that offers futures trading. You’ll likely need a margin account because futures trading involves leverage, meaning you put up only a portion of the contract’s value. It’s important to understand the risks of margin trading and to meet the minimum requirements set by the broker you’re using and the futures exchange as you do this.

Note that the criteria to trade stock futures are more stringent than for stocks and that not everyone may be qualified to trade futures.

Trading requirements and considerations

One common requirement for stock futures trading set by brokerage firms is to maintain a minimum account balance. This is put in place to ensure traders have enough funds to cover potential losses and margin requirements. These amounts vary between brokerage firms, so it’s crucial to understand the specific requirements associated with your account. Falling below the minimum account balance might trigger fees or restrictions on trading.

It's important to consider the risks of trading stock futures. Futures contracts can be highly volatile and prices can fluctuate rapidly. Traders should be well-informed about market conditions and factors that could affect futures prices. Employing strategies such as setting stop orders and diversifying portfolios can help mitigate risk, but they do not eliminate it.

What’s the difference between trading stocks and trading stock futures?

The most obvious difference between trading stocks and trading stock futures is whether you actually own the stock in the first case. When you trade stock futures, you’re buying a contract to buy or sell a stock at a later date.

Another difference between trading stocks and trading futures is that futures contracts are purchased on margin. This means you don’t have to put up the entire cost of the contract – just a percentage, known as the margin requirement. While this might initially seem less risky because you aren’t paying the full cost upfront, it actually introduces more risk. Losses on a futures contract can be much higher because you’re only putting down a fraction of the contract’s value. If the market moves against your position, you could lose more than your initial investment, as you’re responsible for the full value of the contract.

Why are stock futures important to watch for all investors?

Beyond understanding what stock futures are and how they are traded, anyone interested in watching markets may find it helpful to watch stock futures – even if they never intend to trade futures themselves.

Stock futures are valuable indicators for all investors, including non-traders, because they provide early insights into market sentiment and the potential direction of the market before regular trading hours begin.

Because most futures trade nearly 24 hours a day, they capture overnight news, movements in international markets and investor reactions to events that occur when markets are closed. Major economic developments – including jobs report releases, Federal Reserve interest rate decisions and even reporting of geopolitical happenings – often happen outside of regular stock market trading hours. Futures reflect how investors are processing that information.

For these reasons, futures performance may be in the news during periods of market volatility when investors might be particularly interested in monitoring any indicators of where the markets are heading.

The bottom line

Stock futures can be confusing to new investors, and they may be riskier than other investment options. If you are interested in investing in stock futures, do your research; being fully informed can help mitigate your risk.

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