Managed Futures Trading, the History and Evolution
Just over 100 years ago, the futures market was an investment niche with little to no participation. In today’s high paced market, there are now billions traded daily! How did this movement occur so quickly? Well, since futures trading has become so popular, we’ll answer your questions by outlining its history and evolution.
Before there were organized commodity markets, producers (ex. farmer growing wheat or corn) were at the mercy of the buyers. In all reality, the prices offered for the product could be drastically cut, and there was truly nothing the farmer could do. To add to the problem, seasonal surpluses and shortages were dramatically affecting prices year round. These conditions left the agricultural markets volatile for years, hurting everyone from producers to the end consumer. After using this method of price assessment long enough, both the farmers and buyers agreed, it was time for a change.
In 1878, the first central dealing facility was opened in Chicago, Illinois, providing a place for farmers and buyers to deal in “spot grain”, (i.e. immediately deliver their wheat crop for a cash settlement). Shortly after, futures trading evolved as farmers and buyers committed to buying and selling future exchanges of commodities at predefined prices. For example, a buyer would agree to buy 5,000 bushels of wheat in June 2009, for a price that was pre-determined in December 2008. In this scenario, the farmer knew how much they’d be paid come June 2009, and the buyer knew their costs to attain the product. Needless to say, these agreements became very important, allowing both parties to meet demand, define risk, and assess their profit margin upfront.
From the time of the first “dealing facility” until the 1970’s, the commodity markets grew slowly. During that time, the futures markets were only composed of a few farm products. Other than that, it was mostly companies who wanted to hedge a commodity purchase or sale. Since there were very few options to choose from, many still used informal forward contracts, ignoring the benefits of futures. This stagnant growth continued until the government recognized the economic benefit of futures trading. In response, they created a ton of new futures markets, changing the industry forever.
When commodities like metals, energies, foods, industrials, stocks, indices, and interest-rate instruments became tradable, the futures markets exploded! There weren’t limited options like in the past, now investors could trade commodities like crude oil, gold, platinum, coffee, soybeans, cattle, and most importantly, stock indices (Dow Jones, Nasdaq, S&P 500). This change created opportunities for everyone, allowing traders to speculate or hedge in over 20 new markets.
Before the expansion of the futures markets, hedging was the primary goal for both buyers and sellers. At the time, hedging provided a great opportunity for both parties to define their risk and reward. Once the new “tradable” commodities were implemented, the idea of hedging in the futures market started to spread, raising the eyebrows of big businesses. As a result, with every major commodity now being traded, the big corporations had no choice but to hedge. With this monumental change, airlines could now hedge their gas supply, farmers could define profits upfront, jewelers could lock-in gold prices, and far more.
In addition to the new options for “hedgers”, there were huge opportunities for risk tolerant traders. Noticing the profit potential, many traders started to “speculate” on futures prices, profiting from daily price movements. For example, a trader would buy (“go long”) futures, and if commodity price went up, they’d close the trade for profit. Since the futures markets were highly leveraged, speculating became very popular. Once the news spread about the profit potential of futures, investors flooded the market, attempting to profit from this growing trend.
By the end of the 1980’s, many investors had now caught on to the hip world of futures trading. With over $5 Billion dollars of money invested in futures funds, many of the remaining investors had no choice but to jump on the band wagon. This immense growth continued until the new millennium hit, and then commodity trading really took off! By 2004, the amount of money invested in managed futures increased to $131 Billion dollars, growing 2600% in just 15 years. With increased media coverage on the crude oil bubble and $1200 gold, finally, the futures markets are getting the attention they deserve.
As you can see, futures trading is one of the fastest growing markets in the investment world. Though many think of it as a trader’s market, futures are critical to price determination. Think about it, without futures trading, you wouldn’t get that bread or milk for as cheap you do. In fact, many common commodities would be considered a luxury! All in all, futures trading fulfills a critical role in the world, but most importantly, it can become your personal ticket to wealth. Understanding the market is great, but profiting as an investor, broker or trader is even better. If you’d like to learn how to do so, take a look our managed futures category. It covers everything you’ve ever wanted to know about commodities, and a lot more.
We hope this article has helped you appreciate the role of commodity trading, and managed futures investments. Take a few minutes and look at some of our related articles below. It will be well worth your time…
InsideTrade LLC Staff
Phone: (949) 444-2111