Day trading is an exciting practice that lets you bet on the short-term volatility of assets like stocks, currencies, and cryptocurrencies. A wide choice that could represent an obstacle especially for beginners, attracted by some current trend without really knowing what they are trading.
In this article, we will take a deep dive into two popular assets by traders and investors: stocks and futures.
Table of Contents
What are stocks?
Stocks are some of the most popular assets in the world. A single stock represents a single share of a company. Therefore, if a company is valued at $1 million and you own shares worth $500,000, it means that you own half the company.
Similarly, if you own a certain number of Apple shares, it is a sign that you have a certain stake in the company.
Stocks are extremely popular in the United States. It is estimated that most Americans own stocks directly and indirectly through their 401(k). Another growing number of Americans is actively involved in day trading as evidenced by the strong performance of companies like Robinhood and WeBull.
What are futures?
Futures are financial assets that deal with a commitment to buy an item at a future date. The idea started in the commodities market decades ago and has now been embraced by other assets. For example, instead of buying an asset today, the buyer commits to buy at a later date and at a certain price. The later date, in this case, is known as expirely.
A good example of understanding what futures are is to look at an example. Assume that you are a corn farmer who delivers your product to a factory. Today, the price of corn is trading at $10. Therefore, the factory can guarantee to buy your corn in the next season at $12.
In this case, you will be sure that your corn will have a buyer at a better price even if corn prices drop. However, if corn prices rise to about $14, you will be at a loss since you will need to deliver them at that price.
Similarities of trading futures and stocks
There are several similarities when it comes to trading futures and stocks. First, the key driver of stocks and futures prices is demand and supply. Stocks prices tend to rise when there is elevated demand and limited supply.
Analysis
Second, trading the two requires an in-depth fundamental, technical, and price action analysis.
In fundamental analysis, you will look at the key drivers of the asset prices like news and economic data. In price action, you will focus on the underlying chart patterns and in technical analysis, you will use indicators like moving averages and the Relative Strength Index.
Margin
Third, depending on your broker, you can easily use margin to amplify your trades. By using margin, the broker will extend to you a loan that you can use to trade. While margin is a good thing, it is often risky when things start going south.
Differences between futures and stocks
There are a number of differences between stocks and futures. Let us look at a few of these differences.
Assets
The first difference between the two is that stocks are primarily shares of companies that are listed in an exchange that you can trade. On the other hand, futures are more diverse in terms of assets. For example, there are futures on currencies, commodities, and cryptocurrencies.
Level of trading
Futures and stocks are all assets that can be traded by any person. However, in most cases, futures are usually traded by advanced traders who understand the terminology and strategies.
On the other hand, most stocks are now held by institutional investors in form of index funds. Most individual traders focus on stocks instead of futures.
Expiry date
Another difference between futures and stocks is the expiry date. Ideally, whenever you buy a stock, you can hold it forever. For example, we know that Warren Buffett has bought and held some stocks for over 50 years.
In futures, there is an expiration date, which is usually an agreed date by the participants. Recently, however, a new form of futures in cryptocurrencies known as perpetual been introduced. This form of futures contract does not have an expiry date.
Ownership
As mentioned above, there is a difference of ownership when it comes to stocks and futures. When you own stocks, you have a stake in a company and are eligible to receive a dividend. This trait does not apply in the futures market.
Pattern Day Trader Rules
In stocks, there is a rule known as the pattern day trader rule that allows your broker to freeze your account when you make certain types of trades. This happens mostly to small traders who have less than $25,000.
The PDT rule does not apply in the futures market, meaning that you can trade as much as you want without being referred to as a pattern day trader.
Time to trade
The stock market is usually open for a limited number of hours every day. In the US, the market opens at around 9 am and closes by 4:30 pm. As a result, many people are usually not able to trade because of their work responsibilities. The futures market, on the other hand, is usually open for more hours.
Pros and Cons of futures trading
There are several advantages and disadvantages of futures trading. Let us look at the pros first. First, futures can help an investor to offset their losses in stocks. Second, by using leverage, it is easy to optimize your profitability. Further, as mentioned, the futures market is typically opened for more hours than the stock market.
On the other hand, there are some disadvantages of using futures. For example, while leverage can help you optimize your profits, it can be dangerous if the market goes against you. Also, at times, the pricing of futures can lead to a loss.
Summary
In this article, we have looked at the concept of stocks and futures trading. We have identified what they are and noted their pros and cons. Most importantly, we have identified some of the differences between the two.
Externa Useful Resources
- What are the advantages to trading futures instead of stocks? – Quora
