Many people describe themselves as e-mini marketers. In fact, when you trade with e-mini contracts, you are actually a derivative trader. The mass market failure, which lasted from late 2007 to 2009, is widely blamed on poorly established derivatives. Futures markets were generally not blamed for the market crash, but another derivative and very weakly built forward contracts, called credit default swaps, exacerbated the downward trend in the market as Investment Banks were unable to finance the derivatives they wrote in this category. . Many of the largest Investment Banks went bankrupt immediately because they could not pay the huge losses on CMOs as the housing market weakened and had to repay their mortgage loans with credit losses. As you probably know, they failed in this regard and demanded mass cash from the government in order to survive.
What is a derivative?
A derivative is a financial instrument that derives its value from a fixed asset. This is very easy to understand. For example, the value of an ES contract is estimated based on the price of the cash market S&P index. There are many derivative contracts out there, and understanding the universe of these contracts can take a long book to easily explain. We will stick to the basics.
Organizational traders are the largest consumers of these products and generally use them to protect themselves from losing money. This is called a hedge. On the other hand, smaller day traders generally fall into the category of speculative derivative traders. Speculative traders generally try to buy or sell these contracts at a price they believe the market will move up or down, and make a profit or loss through short-term trading to take advantage of the changing nature of these instruments.
How do derivatives work?
These contracts are sold for zero. There is a party that wants to sell at the same price for every trader who buys an e-mini contract. The basic concept to be understood here is that there is a suitable losing trader for each winner. Futures are a basic trading model to understand when trading. There is no unique trade in the NYSE. It is not uncommon to see a large market movement come to a halt as the supply of buyers or sellers declines and the futures market comes to a screaming stop, at least temporarily. From grains to corn to air futures, there are derivatives on every commodity you can imagine. (that future still amazes me)
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What is the risk in futures?
There are a number of risks involved in trading derivative contracts, which, as I said earlier, cover futures contracts. Because futures contracts are highly used and you can throw a cash without being able to say “boo” without proper money management, volatility is a major concern for small traders.
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In addition, in the financial crisis that began in 2007, the problem was the risk of the opposite party. If you are buying a futures contract, you need to have a reasonable assurance that the seller can continue until the end of the transaction. The opposite is called side risk, and was the essence of the problems in the recent market crash; investment banks did not have sufficient reserves to meet their obligations under credit default swaps and forward contracts.
In summary, derivatives are used for hedging and speculation. They provide the required liquidity in the financial markets, but must be balanced by the above average risk associated with it. There is a boom for trading, but careful preparation is needed to make trading successful. As always, good luck with your business.