Futures predate stocks by several thousand years. One of the
earliest recognized futures transactions was the Chinese rice futures of
6,000 years ago.
In the seventeenth century, Japan instituted the first organized rice futures exchange. Japanese merchants would store rice in warehouses for future use. Warehouse holders would in turn sell receipts against the stored rice.
Gradually, these "rice tickets" became accepted as general currency, and rules were developed to standardize their exchange. The agricultural problem that existed 6,000 years ago in China-maintaining a year-round supply of a seasonal product-reared its ugly head in the United States' Midwest of the 1800s.
Today's commodity exchanges resemble the rice futures exchange of Japan the most. They have adopted complete standardization for each commodity as well as delivery locations.
While today's commodity contracts come in various amounts, move on differing price scales, and are delivered in various months, they each contain all of these three elements on their ticker symbol: contract name, month of delivery, year, and price. They are all also self-consistent when it comes to their standardization.
Hedgers and Speculators
With globalization there is a challenge of meeting a constant demand for goods and products as well as properly moving supplies around so nothing goes to waste. This demand-and-supply battle affects all types of products or events. From livestock, manufacturing processes, currency, weather, as well as all products that are of a cyclical nature.
The solution to this problem has lead to the development and maturation of futures trading. In the 1840s, we saw the Midwest become the hub for railroads and telegraph lines. We saw the invention of many agricultural tools that increased overall production levels. All of these events combined to make an efficient agricultural acquisition and distribution system.
While futures contracts were already trading in Liverpool, England; Chicago sat in the middle of all of the United States' activity at the time and thus became the hub of futures trading.
In 1848, a central location was developed in Chicago for farmers and dealers to meet and purchase "spot" grains. The farmers would get cash for immediate delivery of the grains. While this was an effective way to get rid of current supplies, the system was flawed in two ways. Farmers had no standard quantities or quality of product. Not having set standards made many farmers have a difficult time in getting the best prices for their goods.
Farmers (sellers) and dealers (buyers) would also make deals for "future" purchases. They would do this to lock in favorable prices ahead of time. This was a big departure from the practice of cash and carry and required a great deal of trust between the two parties. Since delivery and payments could be months in the "future".
For example, a farmer and a dealer would agree on a price for delivery of 1,000 bushels of corn at the end of May. This was acceptable to the farmer (seller) because he knew how much he would be paid for his corn in advance. He could budget for seeds, hired help, planting equipment, and any other necessary expenses a head of time, and then calculate his profit margins accordingly. The dealer (buyer) enjoyed this scenario because he knew his raw material costs in advance and could calculate his necessary resell mark up accordingly. Each side would put up a small amount of money as a good faith deposit to guarantee the agreement. These two groups, farmers and dealers, became known as "hedgers".
By creating these "future" or "forward" contracts the farmer and dealer had essentially created a credit opportunity for each other. Instead of a cash and carry situation fraught with uncertainty, their agreement with each other had essentially made their activity into a business, which could show potential cash flow and could project earnings.
These contracts became well received by the banks and allowed both parties to be eligible for loans and lines of credit. These contracts became so well respected, that both dealers and farmers were able to sell their contracts to third parties. These third parties were often other dealers and farmers willing to deliver or accept delivery on the contracts. Some dealers and farmers would also buy and sell these additional contracts to make sure that they had gotten the best possible price on their original contracts.
Then there were third parties that also purchased and sold contracts solely to capitalize on weather or market conditions that affected the price of the grains. These parties became known as "speculators." They never intended to make or take delivery of the actual grains, nor were they farmers or dealers. They wanted to simply buy high, sell low or sell high, buy low. Sound familiar?
Thus evolved the commodity exchanges and the two party system of trading, the "hedgers," the ones in the know, and the "speculators," the ones that think they are in the know.
The spot market never went away; it was complimented by the futures market, and later the option market. Creating three different ways for farmers and dealers to buy and sell their products.
Over the past 150 years, futures trading has grown from grains to gold, cattle to coffee, and much more. Indices such as the Dow Jones, S&P 500, and Nasdaq 100 are all accessible as futures contracts. Even blue-chip stocks, such as GE, AT&T, and Ford, have a futures component.
In the seventeenth century, Japan instituted the first organized rice futures exchange. Japanese merchants would store rice in warehouses for future use. Warehouse holders would in turn sell receipts against the stored rice.
Gradually, these "rice tickets" became accepted as general currency, and rules were developed to standardize their exchange. The agricultural problem that existed 6,000 years ago in China-maintaining a year-round supply of a seasonal product-reared its ugly head in the United States' Midwest of the 1800s.
Today's commodity exchanges resemble the rice futures exchange of Japan the most. They have adopted complete standardization for each commodity as well as delivery locations.
While today's commodity contracts come in various amounts, move on differing price scales, and are delivered in various months, they each contain all of these three elements on their ticker symbol: contract name, month of delivery, year, and price. They are all also self-consistent when it comes to their standardization.
Hedgers and Speculators
With globalization there is a challenge of meeting a constant demand for goods and products as well as properly moving supplies around so nothing goes to waste. This demand-and-supply battle affects all types of products or events. From livestock, manufacturing processes, currency, weather, as well as all products that are of a cyclical nature.
The solution to this problem has lead to the development and maturation of futures trading. In the 1840s, we saw the Midwest become the hub for railroads and telegraph lines. We saw the invention of many agricultural tools that increased overall production levels. All of these events combined to make an efficient agricultural acquisition and distribution system.
While futures contracts were already trading in Liverpool, England; Chicago sat in the middle of all of the United States' activity at the time and thus became the hub of futures trading.
In 1848, a central location was developed in Chicago for farmers and dealers to meet and purchase "spot" grains. The farmers would get cash for immediate delivery of the grains. While this was an effective way to get rid of current supplies, the system was flawed in two ways. Farmers had no standard quantities or quality of product. Not having set standards made many farmers have a difficult time in getting the best prices for their goods.
Farmers (sellers) and dealers (buyers) would also make deals for "future" purchases. They would do this to lock in favorable prices ahead of time. This was a big departure from the practice of cash and carry and required a great deal of trust between the two parties. Since delivery and payments could be months in the "future".
For example, a farmer and a dealer would agree on a price for delivery of 1,000 bushels of corn at the end of May. This was acceptable to the farmer (seller) because he knew how much he would be paid for his corn in advance. He could budget for seeds, hired help, planting equipment, and any other necessary expenses a head of time, and then calculate his profit margins accordingly. The dealer (buyer) enjoyed this scenario because he knew his raw material costs in advance and could calculate his necessary resell mark up accordingly. Each side would put up a small amount of money as a good faith deposit to guarantee the agreement. These two groups, farmers and dealers, became known as "hedgers".
By creating these "future" or "forward" contracts the farmer and dealer had essentially created a credit opportunity for each other. Instead of a cash and carry situation fraught with uncertainty, their agreement with each other had essentially made their activity into a business, which could show potential cash flow and could project earnings.
These contracts became well received by the banks and allowed both parties to be eligible for loans and lines of credit. These contracts became so well respected, that both dealers and farmers were able to sell their contracts to third parties. These third parties were often other dealers and farmers willing to deliver or accept delivery on the contracts. Some dealers and farmers would also buy and sell these additional contracts to make sure that they had gotten the best possible price on their original contracts.
Then there were third parties that also purchased and sold contracts solely to capitalize on weather or market conditions that affected the price of the grains. These parties became known as "speculators." They never intended to make or take delivery of the actual grains, nor were they farmers or dealers. They wanted to simply buy high, sell low or sell high, buy low. Sound familiar?
Thus evolved the commodity exchanges and the two party system of trading, the "hedgers," the ones in the know, and the "speculators," the ones that think they are in the know.
The spot market never went away; it was complimented by the futures market, and later the option market. Creating three different ways for farmers and dealers to buy and sell their products.
Over the past 150 years, futures trading has grown from grains to gold, cattle to coffee, and much more. Indices such as the Dow Jones, S&P 500, and Nasdaq 100 are all accessible as futures contracts. Even blue-chip stocks, such as GE, AT&T, and Ford, have a futures component.
Noble DraKoln is founder of Speculator Academy, http://www.speculatoracademy.com.
After becoming a licensed broker at the age of nineteen, he has gone on
to author seven trading books. He is a former editor of Futures
Magazine, regular contributor to Forbes, has been a featured guest on
numerous financial channels, and is a sought after consultant speaker in
the futures, forex, and options world. Needless to say his twenty-one
years in the industry have been well spent.
He is also the author of the books Trade Like a Pro, Winning the Trading Game, published by Wiley and Sons, and the author of four book "Small Speculators Series".
His books have been translated into German, Romanian, and is currently being translated into Chinese, Korean, and Spanish.
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He is also the author of the books Trade Like a Pro, Winning the Trading Game, published by Wiley and Sons, and the author of four book "Small Speculators Series".
His books have been translated into German, Romanian, and is currently being translated into Chinese, Korean, and Spanish.
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