These exchange-traded instruments enable you to make bets on the price movements of commodities and currencies — but make sure you are aware of the risks.

(LifeWire) — If you drive, you’re well aware of the day-to-day swings in the price of gasoline. If you need gas on Tuesday, you pay Tuesday’s retail price. This is the spot market. Each day, the gas station may raise or lower its price, and customers pay the posted rate.

Now imagine you’re a next-day shipping company with a fleet of trucks. You’ve already committed to delivering packages, and you can’t afford to take a risk that the price of gasoline will suddenly spike. You might want to make a deal with the gas station to prepay for all of the gas you’ll need for three months at today’s prices.

In this kind of arrangement, known as a forward contract, both sides get some measure of protection: The gas station owner is protected from a decrease in gas prices and locks in a big sale, and the shipping company is protected from an increase. A more basic example is a two-year magazine subscription: You lock in today’s price, so even if the subscription goes up in price, you don’t pay any extra.

From Forward Contracts to Futures

Futures are simply forward contracts that are standardized in a way that makes them interchangeable. As a result, they can trade on exchanges just as stocks do. Each futures contract is stamped with a size (a number of bushels or gallons), a delivery date and the protection of a third party known as a clearinghouse, which ensures that both sides keep up their ends of the bargain.

This level of standardization makes futures a favorite tool of investors who are looking to participate in the commodities and currency markets. On the Chicago Mercantile Exchange, you can buy and sell futures in many kinds of products. These include:

• Commodities. lumber, milk, hogs, cattle
• Currencies. euro, pound, yen, Canadian dollar
• Interest rates. London interbank rate (Libor), eurodollar rate (interest paid by foreign banks on US deposits)
• Stock indexes. Standard & Poor’s 500, Nasdaq 100
• Alternative investments. weather, economic indicators

Why Trade Futures?

There are two kinds of futures traders: hedgers and speculators. The shipping company in the example above is a perfect example of a hedger. A pastry company might want to lock in the price of milk to be sure that the prices in its annual catalog won’t be out of date, so it might buy futures on milk.

A speculator purchases or sells a futures contract to benefit from an expected change, on the basis of his or her belief about what will happen in the future. Think it’ll be a very hot summer? Expect the euro to plummet? If you’re willing to make a bet — and these bets can be far riskier than a bet on a stock — you might consider futures trading. (You can easily lose your shirt, though — read on.)

Speculators don’t have any interest in taking possession of pork bellies — they’re just betting on the direction of the price of pork bellies. This kind of speculative trading dominates the futures market. How do we know this? According to the CME, only 3% of futures contracts lead to the physical delivery of the item that they cover, such as milk. The remainder are offset — canceled out with an opposite, equivalent transaction — before they expire.

Why Non-Traders Should Care

Even if you don’t trade futures, understanding them can help you be a more alert investor in the stock market. For instance, futures contracts on the Standard & Poor’s 500 index that trade before 9:30 a.m. Eastern time can point to the initial direction of US stocks. Looking at the market prices for crude oil to be delivered next month might help you see the market’s best guess for the direction of energy prices.

This is a feature of futures trading known as price discovery — the machinations that ensure, in most cases, that the price reflects the market’s true assessment. Also, your mutual fund manager may use forward contracts to hedge or speculate, so learning the language can help you understand what your money manager is up to.

The Allure and Risks of Margin

When buying futures, you pay only a fraction of the true cost of the underlying item. For instance, say you buy a contract for 5,000 bushels of soybeans for delivery in July, and the market price for the contract is $30,000, or $6 a bushel. You might make only a $1,000 deposit as a good-faith gesture, rather than pay $30,000 up front.

This kind of leverage makes the futures market a place where fortunes are won and lost. Say soybean prices for July rise just 10 cents the next day. Across 5,000 bushels, that’s a $500 gain. If, instead, prices fall 20 cents the next day, you’re out $1,000. Your broker will come to you and demand an additional good-faith deposit — a margin call, in trader parlance — of another $1,000.

Because futures trading requires a vigilant eye, many traders use stop orders as protection. A stop order is a standing instruction given to a broker to close out a contract if the price of a futures contract hits a specified level.

For More Information

The Chicago Mercantile Exchange Education Center offers a primer on futures .

The Chicago Board of Trade Education Site offers classes and training seminars in commodities trading .

The National Futures Association, an independent regulatory organization, has an online Investor Learning Center .