If you have the gold bug and want to get in on trading this commodity, the financial markets offer several ways to do so. Trading futures on the price of gold allows you to leverage your trading capital and book some nice profits on relatively small price changes in the precious metal. Be aware, though, that futures losses can bite hard if you guess wrong on the price direction.
Gold Futures Basics
Futures contracts — as the name implies — provide for the future delivery of a specific commodity or other instrument. The standard gold futures contract is for the delivery of 100 troy ounces of gold. Gold futures have a range of contract dates including monthly for the next two months and up to six years in the future. A futures contract buyer locks in the right to buy gold at the current contract price, and a seller locks in the same price to deliver the gold on the contract date. Traders, who have no interest in actually buying or selling gold, can buy and sell futures contracts to profit from the changing price of the metal. To avoid delivery, a futures trade can be closed out or rolled to a future gold futures contract.
Margin Deposit to Trade
The feature that makes trading gold futures so potentially attractive is the leverage obtained due to the low deposit required to trade. If, for example, gold is at $1,650 per ounce, one futures contract has a value of $165,000. However, to trade one contract, the commodity futures exchange requires a trader to put up a margin deposit that's only a small fraction of that. At the time of publication, the initial margin for a gold contract was $7,425. Thus, trading gold futures allows a trader to "control" a large value of gold with a much smaller amount of money on deposit.
Calculating Profit and Loss
Since the margin deposit required to trade a gold futures contract is just a fraction of the value of gold represented by the contract, the profit or loss from a futures position is a multiple of the change in the price of gold. In futures trading, the minimum price change is called a "tick." With gold, one tick is 10 cents per ounce and worth $10 per contract. So if the price of gold changes by 50 cents or 5 ticks, the trader lost or gained $50. Every dollar change in the price of gold is worth $100 up or down on a futures contract.
Futures allow trading in either direction. If you think gold is going up, open a trade with a buy order. To profit from a falling gold price, you enter a sell order to open. Your profit or loss is calculated from the price of the futures contract when you placed the trade. Commodity brokers balance out trader accounts at the end of each day. If you made money on a gold futures trade, the gain is "swept" into your account, leaving the initial margin amount on deposit. If you lost money, the loss is subtracted from your margin deposit and if the result is less than the maintenance margin — currently $6,750 for gold -- the broker will ask you to put more money on deposit to bring your margin back up to the initial margin amount.
In recent years, the futures exchanges have developed e-mini and e-micro contracts with smaller values, making it easier for individual traders to get in on the action. The e-micro gold futures contract is for 10 troy ounces of gold. With this contract all of the numbers -- contract value, margin deposit and tick values -- are 1/10th the size of the standard gold futures contract, or, at the time of publication, $743 -- so beginning and small-account traders can get in on the game.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.