Trend Following with Managed Futures

CHAPTER 2

Review of Futures Markets and Futures Trading

This book is focused on demystifying both the art and the science of trend following from the perspective of the end user, the institutional investor. This chapter is an introduction to the background necessary for understanding the basics of futures markets, futures trading, and the managed futures industry. Due to ease of trade and relatively high level of liquidity, trend following systems trade in futures markets and interbank forward markets worldwide. As a result, an understanding of the key characteristics of forwards and futures contracts and futures markets is essential. These markets offer exposure to a wide selection of asset classes including equities, currencies, hard and soft commodities, and fixed income. The use of derivatives allows for access to leverage and central clearing structures alleviate counterparty risks.

■ Forward and Futures Contract Fundamentals

Even prior to the use of currency exchanges and modern banking systems, people have been trading commodities. Agricultural products have been bought and sold throughout the centuries under systems of exchange, future promises, and barter. A forward contract is an agreement between two counterparties (the buyer and the seller) to exchange a certain good or commodity (the underlying) for a determined price (the forward price) agreed on at the beginning of the contract (agreement time) and delivered at maturity (at settlement). The concept of a forward ...