Trading Mechanism Of Future:
Flow of the Order
Any person who wants to trade in futures has to contact a Futures Commission Merchant (FCM) or a broker. First, let us look at an FCM. He is necessarily a member of the clearing house. The next step is to open an account at his firm. The account holder will be assigned to one of the Accounts Executives, who will look after his transactions. Whenever the account holder places an order with the accounts executive, he will note down the order specifications and immediately transmits it to one of the floor brokers at the exchange. The floor broker will execute the order and report the transaction to the clearing house. Once he receives the confirmation from the clearing house, he calls back the accounts executive giving him all the details about the trade. The accounts executive, in turn, will pass these details to his client.
Other responsibilities of the FCM is to maintain all the records and to report the trading activity of all his clients to the clearing house and sending the clients monthly statements about their position and account balances.
To Open the Account with a Broker
The broker may or may not be a member of a clearing house. If he is a member of a clearing house, he notes down the specifications and transmits the order to the floor broker who, as mentioned above, executes it, confirms it from the clearing house and sends back the details to the broker, who then conveys the same to his client. In case, he does not happen to be a member of the clearing house, he should necessarily route the order through a member. Once he does so, the remaining procedure will be the same as above.
The investor who wants to trade futures can be a hedger, a speculator or an arbitrager. These are defined below.
Hedgers deal in futures to offset a pre-existing risk. The commodity is usually the one they produce or use in the course of their business.
Speculators take long or short positions only with the intention of making profits by getting out of the market when conditions favor them. As with the other markets, speculators play an important role in futures market also. In the process, they assume risk which is disproportionate to the returns they are expecting.
Arbitragers try to exploit the discrepancy between prices in two different markets. This activity is termed as arbitration. In the context of futures market, this treading has a special income spread trading.
Futures Commission Merchant
By this time it should be clear as to what role the FCM plays. Its role is similar to that of a brokerage house in a stock market. Investors interested in dealing in futures may also put through their deals through the contacting agents of FCM. These agents do not accept money from the investors. The agents are also called introducing brokers. The bulk of the business is carried out by FCMs only.