Many people define themselves as e-mini traders. In fact, when you trade e-mini deals you are actually a derivative trader ative 200 late in the mid-2009 mass market failure is attributed to weak structural derivatives. Futures markets were not generally blamed for the market collapse, but another derivative known as credit default swaps and mostly weakly structured forward contracts exacerbated the market’s downward trajectory as investment banks were unable to fund written derivatives in this segment. Many of the largest investment banks were immediately bankrupt due to the inability of the tanked CMOs to cover huge losses in the housing market and they had to do well in the mortgages held in default losses. You are probably aware as they have failed miserably in their responsibility in this matter and need a lot of cash from the government to be sustainable.
What is a derivative?
A derivative is a financial instrument that derives its value from the underlying asset der it is very easy to understand. For example, the price of an ES contract is determined based on the price of the cash market S&P index. There are plenty of derivative contracts out there and the universe of these contracts can take a long book to explain easily. We’ll stick with the basics.
Institutional traders are the largest consumers of these products and they usually use them to hedge against losses in cash positions. This is called hedging. Small day traders, on the other hand, usually fall into the category of speculative derivatives traders. Speculators usually try to buy or sell these contracts at a price where they believe the market will move up or down and will realize a profit or loss by short-term trading to take advantage of the volatile nature of these instruments.
How do derivatives work?
These contracts are traded in a zero-sum setting. There is a party for every trader buying e-mini deals who is willing to sell at the same price. The basic idea here is to have the same losing trader for each winner. The basic trading model to understand when trading futures. There is no comparable trade like buying and selling on NYSE. It is not uncommon to see a moving stall in a large market because the supply of buyers or sellers dries up and the futures market comes to the screeching stall at least temporarily. There are derivatives about every product you can imagine, from corn to weather futures. (That particular future still amazes me)
What are the risks in the future?
There are a number of risks involved in trading derivatives contracts, which I mentioned earlier include futures contracts. Instability is a primary concern for small traders because futures contracts are highly profitable and without proper money management measures you can blow a wad of cash before you say “boo”. Moreover, the problem of the financial recession that began in 2007 was anti-risk to the party. If you buy a futures contract, you need to have a reasonable guarantee that the seller can finish the bargain. This was called counter party risk and it was the culmination of the last market crash problem; Investment banks do not have sufficient reserves to meet the promises they made through credit default swaps and forward agreements.
In short, derivatives are used to hedge and estimate. They provide the necessary liquidity in the financial markets but it has to be balanced with the above average risk associated with them. These are an explosion for business, but they need to be carefully prepared for the trade to emerge successfully. As always, good luck in your trading.