Speculating with futures contracts should not be undertaken without a thorough understanding of the market and risks involved. The highly geared nature of these products means that a sizeable market exposure can be established, far in excess of the funds on deposit.

Speculators need to consider risk/reward ratios, ways of limiting losses, and time horizons. They also need to plan their trades carefully. Many pure futures traders use detailed technical analysis in an attempt to work out potential price patterns.

Outlook:

Suppose you are following the sterling/dollar exchange rate, believing sterling will weaken further against the dollar. Using CME British Pound futures, which are trading at $1.5000, you short the market at this level.

Price move:

As expected, sterling continues to depreciate against the dollar, reflected by a decline in the futures price to $1.4880, or a 120 points movement. For the CME British Pound contract, each point movement is worth $6.25, so for one contract this means a profit of $750

Returns

Although this contract is based on £62,500, it can be established with a "margin" deposit set by the exchange of $1,688, so the return in this case per contract of $750 represents a return of over 40%.

This is based on a movement in the exchange rate (as expressed in the futures price) of 0.012, out of $1.5000, or 0.8%. This clearly demonstrates the gearing potential of futures contracts.