Stocks and Futures: What is the Difference?
If you’ve been trading or reading about trading for a while, you have surely happened upon the words “Stocks” and “Futures,” which everyone seems to casually drop about conversations, and you have no doubt more than once wondered to yourself: “What on earth is all this about?” Don’t worry, Banc De Binary is here to explain!
Ownership vs. Contract
Stocks are actually tiny pieces of ownership that a company makes public, and when you buy a stock you actually buy a share of the company—hence stocks are also called shares. When you consider buying a stock, you do so because you believe a company’s performance will improve over time, thus giving you, the shareholder, more value for your investment.
Futures do not deal with companies, but with commodities (such as gold, wheat, oil, etc.), and are not ownership titles, but mere contracts about future transactions. When you buy (or sell) a Future you enter into a contract for the right to buy (or sell) the underlying commodity for a set price in the future. In Futures trading, moreover, you can make money both from falling and rising prices. For example, if you think that the price of a commodity will rise in the future, you can enter a contract to buy that commodity at the current price hoping to sell it at the end of your contract for a higher price. If you suspected that the price of a commodity will fall, you can enter into a contract to sell it (even without buying first), hoping to buy it back later at a lower price to pocket the difference.
Market Liquidity
Both stocks and contracts require a buyer and a seller in order for a transaction to be completed. Stocks, however, are quite finite, as their number in circulation depends on the number of shares published by the company. As traders, furthermore, usually buy stocks for long-term investment planning to hold on to them until the price rises, it is possible that an interested buyer will not find any available stocks on the market.
Futures are quite liquid and usually present no dearth in neither buyers nor sellers. Because futures can turn profitable whether prices fall or rise (if the investor takes the right steps) there are always interested buyers and sellers.
Time Limits
Shareholders often “sit” on stocks for as long as they like while waiting for prices to rise to make a profit. When prices are dropping, the investor loses part of the original investment, but no extra capital and thus can afford to wait for prices to rise again.
Futures contracts always come with an expiry month, quoted as date of delivery. Unless you actually plan to take delivery of the commodity, you want to exit your contract before the expiry date and therefore you cannot “sit” on the investment forever, waiting for the price to move in a direction favourable to you. As the date of delivery approaches your chances for exchange become slimmer forcing you to close your trade even if it turns out to your disadvantage.