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Futures Contracts: the Essential Facts

Futures contracts, whether it be about commodities or forex currencies, have several components that a forex trader should be aware of. Of the numerous aspects, among the most important are the contract units and price system structure.

Contract units, in futures market parlance, refer to the specific quantity in each contract. For instance, the contract units for physical commodities can be 2,000 bushels of wheat, 500 barrels of oil or 3,000 ounces of platinum. Treasury bills are measured in dollars. In forex and futures cash settlements, a different method is utilized. An index number is used, and its value is expressed in decimal points

Because of the variety of methods involved, it is imperative that you conduct research, or at least consult your broker, regarding the method or instrument that will be used in each futures transaction that you will enter into.

As with contract units, price structures in futures vary considerably. In futures commodities and deliveries, dollars and cents are used (i.e., $60 per barrel, $12.50 per wheat bushel). In transactions involving forex currencies, the same method is used. In cash settlements, decimals are used, obtained from an index figure in a stock futures (i.e, .60 in the S&P 500).

There are a few other things that a forex trader or investor has to learn about futures contracts, namely Minimum Price Changes, Daily Price Limits and Position Limits.

Futures exchanges and stocks futures indexes impose certain restrictions with regards to the extent in which the price of a futures contract can move up or down, Minimum Price Changes, known in forex circles as the "tick", is the lowest value the contract is allowed to reach in a trading day.

For instance, if the tick of a 5,000 bushel of wheat is $10, the exchange will stop trading the commodity if the value falls to below that amount. The trading for that futures commodity will commence the following day. Tick size varies with each contract, and so does the Daily Price Limits.

Calculations for price limits take into account the previous trading session's closing value, among others. However, these impositions are usually removed when the settlement date approaches. This should be in your futures contract, so examine it first.

Position Limits were established by the CFTC as a means to prevent too much speculation that could bring about instability to the market. Because it varies with each futures contract, you should consult it with your broker.

Futures contracts are where you will make your profits, or incur losses, therefore no amount of time or effort should be spared here. The more you know about them, the more confident you will be in your transactions.