Speculators Who Trade Commodities in Futures Contracts - dummies

Speculators Who Trade Commodities in Futures Contracts

By Amine Bouchentouf

One group that trades commodities in futures contracts consists of individual traders, investment banks, and other financial institutions who are interested in using the futures markets as a way of generating trading profits.

For some reason, the term speculator carries some negative connotation, as if speculating is a sinful or immoral act. In reality, speculators play an important and necessary role in the global financial system. In fact, whenever you buy a stock or a bond, you’re speculating. When you think prices are going up, you buy. When they’re going down, you sell.

The process of figuring out where prices are heading and how to profit from this is the essence of speculation. So we’re all speculators!

In the futures markets, speculators provide much-needed liquidity that allows the many market players to match their buy and sell orders. Speculators, often simply known as traders, buy and sell futures contracts, options, and other exchange-traded products through an electronic platform or a broker, to profit from price fluctuations.

A trader who thinks that the price of crude oil is going up will buy a crude oil futures contract to try to profit from his hunch. This action adds liquidity to the markets, which is valuable because liquidity is a prerequisite for the smooth and efficient functioning of the futures markets.

When markets are liquid, you know that you’ll be able to find a buyer or a seller for your contracts. You also know that you’ll get a reasonable price because liquidity offers you a large pool of market participants competing for your contracts.

Finally, liquidity means that when a number of participants are transacting in the marketplace, prices aren’t going to be subject to extremely wild and unpredictable price fluctuations. This doesn’t mean that liquidity eliminates volatility, but it certainly helps reduce it.

At the end of the day, having a large number of market participants is positive, and speculators play an important role with the liquidity they add to the futures markets.