The futures market was founded on the principle of risk transfer. Investors seeking to minimize their exposure to certain risks transferred those risks to others who were trying either to protect against an opposite risk, or who were willing to take the risk, in the hope of making a profit.
Buying and selling futures contracts is risky business. Any transaction can result in a loss that exceeds the amount of the initial margin, and could potentially be an almost unlimited amount. Being able to limit losses as they are occurring is not guaranteed. There may be no party willing to sell or buy the offsetting contract you need to prevent further losses. Or, on a day-to-day basis, the market for any particular futures contract may be illiquid, or inactive.
A zero sum game
Investing in the futures market is different from investing in stocks, bonds, and mutual funds because futures markets are
zero sum markets.
That means for every dollar somebody makes (before commissions), somebody else loses a dollar. This means something different for
hedgers
than for
speculators.
Hedgers enter the futures market to protect against price changes. A hedger achieves his goal, even if he loses in the futures market, because his loss is offset by a gain in the cash market.
Speculators, on the other hand, are motivated solely by the hope of being on the right side of the zero sum game.
