The structure of this article includes: 1. The nature of futures 2. Common terms in futures: going long, going short 3. The risks of futures leverage

Let's start with a small story to illustrate the essence of futures.

Zhang San is a wheat producer who owns thousands of acres of fertile land. Every year after the wheat harvest, he sells it to Li Si, a flour processor from the neighboring village.

For example, the current market price for a bag of wheat is 200 yuan, so Zhang San sells a bag of wheat to Li Si at a price of 200 yuan.

Since this bag of wheat is already produced and is being traded at the market price, we call it a spot commodity, which is a ready-made product. What about futures? Futures are about the future.

Continuing the story, because the market price of wheat is not fixed and fluctuates throughout the year, they share a common concern, which is the uncertainty of prices.

Zhang San is worried that the price of wheat will fall in the future and he won't make money, while Li Si is worried that the price of wheat will rise in the future, making the cost of flour too high.

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To solve this problem, a contract came into being. The contract clearly states that three months later, Zhang San's farm will sell a bag of wheat to Li Si at 200 yuan. Now, the price is fixed and both parties can work with peace of mind.

Three months later, Zhang San delivers a bag of wheat to Li Si, and Li Si pays Zhang San 200 yuan as agreed. This contract is fulfilled, and we call it a forward contract.

This is the essence of futures. Futures allow the sale of goods or assets on a certain date in the future and are traded at the price agreed upon today. This price is called the forward price.Futures allow individuals to profit from the price fluctuations of certain assets without actually purchasing the asset itself. Examples include crude oil, gold, and sugar.

What are going long and going short?

Individuals who go long on a futures contract agree to buy at a forward price, while those who go short are obligated to deliver the goods on the delivery date.

Suppose you anticipate a financial crisis and wish to hedge your assets by investing in value products. You decide to go long on gold futures, purchasing 100 ounces at today's price of $1900 per ounce, with delivery set for one year later. Your profit depends on the market price of gold one year from now. If the price is $2000 per ounce after a year, you would make a profit of $10,000; however, if the price drops to $1800 per ounce, you would incur a loss of $10,000.

Conversely, if you believe that a financial crisis is imminent and that the central bank will cut interest rates and stimulate the economy with monetary policy, causing investors to abandon gold for stocks, you might consider going short on gold futures. If the price of gold drops to $1800 per ounce after a year, you would profit $10,000; on the contrary, if the price rises to $2000 per ounce after a year, you would suffer a loss of $10,000.

You might wonder how you would accept or provide so much gold after the contract expires. In reality, the settlement of futures contracts does not necessarily involve physical goods but can also be in cash. After the contract expires, it is only necessary to transfer the money from the losing party's account to the winning party's account based on the market price.

What is closing a position?

At any time before the contract expires, you can terminate the contract and cash out, which is known as closing a position.

For example, if you previously went short on 100 ounces of gold, you can now go long on the same quantity and with the same delivery date of gold futures contracts to close your position. Your profit or loss would be the difference in the futures contract price.

High leverage risk in futures

Futures trading often involves high leverage, which can amplify both potential gains and losses. This means that even small market movements can lead to significant financial outcomes, making it a risky investment strategy that requires careful management and understanding of the market dynamics.In simple terms, futures only require investors to provide a small fraction of the contract value to control a large amount of assets.

If you want to go long on 100 ounces of gold, valued at $190,000, you only need to deposit a margin, for example, 5%, which means you only need to provide $9,500.

However, the potential for high returns comes with the risk of substantial losses. If the gold price drops to $1,500, you would lose $40,000, which is more than four times the margin.

Futures are not suitable for beginners. If you try to trade futures based on your experience in stock trading, you are very likely to end up bankrupt. It can be described as a heaven or hell in a single thought, winning can make you rich overnight, while losing can leave you with nothing but the wind on the rooftop.