What is futures trading? Futures trading is the buying and selling of futures contracts. These are contracts that involve the purchase or sale of an underlying instrument at a set price on a certain date. For example one might enter into a contract that requires the purchase of 100 oz of gold for $600/oz in January 2007.

There are futures contracts in currencies, equities, commodities and other financial instruments. What are the advantages of futures trading? There are a number of advantages to futures trading compared with trading the underlying instrument directly. The main is leverage, i.e. the amount of exposure to the underlying instrument that you can get for a given outlay of money.

Using the example above, the initial outlay will usually be only a fraction of the value of the contract, called ?margin?. Thus the investor gains exposure to 100 oz of gold for just a few hundred dollars. Another advantage of futures trading is, given the liquidity of the futures market, transactions costs are usually very competitive.

A further advantage is that investors can usually go ?short?, i.e. they can be the seller in the futures contract. This is an advantage if they believe the price of the underlying instrument is set to fall. Finally there may be tax advantages compared with normal investing depending on the local taxation regime.

What are the disadvantages of futures trading? Leverage works both ways. If an investor purchases a futures contract, paying only the margin, and the price of the underlying asset falls, then investors can lose more than their original stake.