Futures Trading Pit

Futures pit traders

Each day, billions of dollars exchange hands as people buy and sell everything from oats to weather futures. This is because, minute by minute, the value of these commodities is changing, which affects everything from the price you pay at the pump to the price you pay for a bowl of cereal.

The quoted price for commodities is based on the supply and demand trends for that particular commodity, but all the buying and selling is done well away from any farmer's field or mine, and most transactions are executed without the participants ever seeing a bushel of soybeans or bar of gold. Read on to find out how this fast-paced and exciting market works.

Futures Exchange Beginnings
By the middle of the nineteenth century, producers and consumers of commodities started organizing market forums to make buying and selling easier. These markets helped to establish quality standards and rules of business. In their heyday, there were more than 1, 600 of these exchanges all across the U.S., mostly at major railheads or ports. (To learn more, read .)

In the beginning, mostly agricultural goods were traded, but any market can flourish as long as there is an active pool of buyers and sellers. In Japan, for example, cocoons (for silk) are traded as an exchange-traded commodity. Over time, improvements in communications and transportation cut the need for so many local exchanges. Centralized warehouses in New York and Chicago could distribute the goods more economically; as a result, today's major U.S. commodity exchanges are in Chicago and New York.

Futures Exchanges of Today
The exchanges we see today are the result of the consolidation of the smaller exchanges. This consolidation is ongoing - for example, the Intercontinental Exchange and the New York Board of Trade merged in 2006 and the Chicago Mercantile Exchange and the Chicago Board of Trade also consolidated in 2007.

One hundred years ago, there were more than 1, 000 exchanges in the U.S. Today, there are fewer than 10.

Years ago, the physical commodities were brought to the marketplace for the buyers to inspect; they would then bid on what they needed. The buyers would try to out-bid other buyers while the sellers would try to lower their prices to beat other sellers, thus creating the market.

In the present day exchanges, the physical goods are nowhere to be found and instead, traders use futures contracts. A futures contract is a legally binding contract to buy/sell a particular commodity of a specific grade at a specific price and location on a specific date. The contracts are standardized so that all market participants are on the same playing field. (To learn more about how commodities are traded, read and .)

Participants
Futures contacts are most widely used for hedging. Hedging allows producers/consumers to better estimates costs and offset risk due to market movement. Hedgers have been known to take delivery of goods. (For more on this, read and .)

Speculators, on the other hand, try to profit from market direction and take on market risk. They usually have no need for the physical commodity, but instead try to profit on having the market go their way.

Speculators play an important role in the market price because they bring volume and liquidity. Without them, markets can dry up due to lack of buying and selling. Some exchanges, like the New York Stock Exchange, use a special type of broker who is required to trade certain stocks, ensuring liquidity. These are called specialists or market makers. It is important to note that the exchanges have no effect on the prices of the products traded. Prices are determined by the market participants, be it hedgers or speculators. If there are more buy orders than sell orders, the market will go up and vice versa. Although this process is now completed electronically, this used to be done in pits in a process called open outcry.

LIVESTOCK-CME hog futures end mostly higher on short-covering  — Reuters
Packers may again try to pressure cash prices this week by drawing from cattle that were contracted against the futures market, traders and analysts said.

Popular Q&A

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What are the top mistakes for future traders?

The top mistakes for future traders are not sticking to your system, not protecting yourself, not staying focused, and not being open to new ideas because the market is always changing.

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