Backwardation happens when the current price of something falls relative to the future price. Commodities are raw materials that can be used to make other products or services. If future prices fall too much, investors are faced with a loss. This is called the "Contango Effect".
Contango
A situation in which futures and spot price of a commodity are convergent is called contango. If the futures prices are higher than the spot, then the futures contract has entered a backwardation status. This is when the demand for the futures contracts outweighs its supply. In this case, spot and futures prices are likely to rise in the future. This means that a contract bought for $75 will eventually go up to $70 and vice versa.
Traders prefer trading contango over backwardation. Backwardation occurs when the futures price exceeds the spot price. Backwardation is a way for traders to make money by purchasing futures contracts in the hope that the price will rise. Trader may be tempted to believe that the market is not as strong as they expect. However, futures prices could fall below the price forecast. This is a risky situation for traders. It's better to stay with the trend.
The term "contango", while it applies to options and futures, is also applicable to commodity futures as well as leveraged exchange traded funds (ETFs). The opposite management mantra may be the case with exchange-traded funds, as they follow the opposite management mantra. It's understandable to wonder why anyone would make an investment in an ETF which follows the opposite management strategy. But it's not uncommon in futures, options and other markets.
Traders looking for a long-term investment opportunity should consider the potential risk of the market's movement in the direction of the forward contract price. If the market moves towards the futures price, the price of the futures contract will fall. It will usually equal the maturity spot price. But, the market is at risk of falling. A good way to determine whether or not to buy or sell a commodity is in a backwardation situation is by examining its price graph.
Another strategy that many traders use to manage their risks involves laddering. Laddering is a way to hedge futures contracts. This strategy is where one buys the most expensive contracts, while selling the least expensive. Traders can thus minimize their losses from contango and reduce their risks of backwardation. It is better to be safe that sorry. Additionally to laddering, it's advisable to be cautious regarding leveraged and commodity ETFs.
FAQ
What are the advantages to owning stocks?
Stocks have a higher volatility than bonds. The value of shares that are bankrupted will plummet dramatically.
If a company grows, the share price will go up.
Companies usually issue new shares to raise capital. Investors can then purchase more shares of the company.
To borrow money, companies use debt financing. This gives them cheap credit and allows them grow faster.
Good products are more popular than bad ones. The stock price rises as the demand for it increases.
The stock price should increase as long the company produces the products people want.
Why is a stock security?
Security is an investment instrument whose value depends on another company. It could be issued by a corporation, government, or other entity (e.g. prefer stocks). If the underlying asset loses its value, the issuer may promise to pay dividends to shareholders or repay creditors' debt obligations.
What's the role of the Securities and Exchange Commission (SEC)?
SEC regulates securities brokers, investment companies and securities exchanges. It enforces federal securities regulations.
Statistics
- Even if you find talent for trading stocks, allocating more than 10% of your portfolio to an individual stock can expose your savings to too much volatility. (nerdwallet.com)
- Ratchet down that 10% if you don't yet have a healthy emergency fund and 10% to 15% of your income funneled into a retirement savings account. (nerdwallet.com)
- The S&P 500 has grown about 10.5% per year since its establishment in the 1920s. (investopedia.com)
- Individuals with very limited financial experience are either terrified by horror stories of average investors losing 50% of their portfolio value or are beguiled by "hot tips" that bear the promise of huge rewards but seldom pay off. (investopedia.com)
External Links
How To
How to Trade in Stock Market
Stock trading involves the purchase and sale of stocks, bonds, commodities or currencies as well as derivatives. The word "trading" comes from the French term traiteur (someone who buys and sells). Traders are people who buy and sell securities to make money. It is one of the oldest forms of financial investment.
There are many options for investing in the stock market. There are three basic types of investing: passive, active, and hybrid. Passive investors are passive investors and watch their investments grow. Actively traded investor look for profitable companies and try to profit from them. Hybrid investors combine both of these approaches.
Passive investing involves index funds that track broad indicators such as the Dow Jones Industrial Average and S&P 500. This approach is very popular because it allows you to reap the benefits of diversification without having to deal directly with the risk involved. Just sit back and allow your investments to work for you.
Active investing involves selecting companies and studying their performance. Active investors will look at things such as earnings growth, return on equity, debt ratios, P/E ratio, cash flow, book value, dividend payout, management team, share price history, etc. They then decide whether or not to take the chance and purchase shares in the company. If they feel that the company's value is low, they will buy shares hoping that it goes up. They will wait for the price of the stock to fall if they believe the company has too much value.
Hybrid investing blends elements of both active and passive investing. Hybrid investing is a combination of active and passive investing. You may choose to track multiple stocks in a fund, but you want to also select several companies. In this case, you would put part of your portfolio into a passively managed fund and another part into a collection of actively managed funds.