Crops, Pigs And ETFs: A Short History Of The Futures Market

Today, online commodities and futures trading involve hundreds of billions of dollars changing hands at any one time. It's a massive and important part of the modern financial sector.

However, most Americans don't know of its existence or how the sector works. These are unlike some financial instruments that exist to speculate and make money. Commodities and futures trading are time-tested practices that have only grown in sophistication and importance over time.

How It Got Started

The commodities and futures market started in the 1600s as a collaboration between farmers and banks to help control the risks that farmers faced on a yearly basis. This was a transfer of risk similar to a good homeowner's insurance policy or a shorted stock.

Farming was and still is a risky venture. There's always a considerable possibility that the harvest will fail and crops will not get to market. However, a bumper crop is almost as problematic for the average farmer. More crops on the market mean a lower price for each farmer's harvest and less money to buy the essentials for harvest.

Therefore, farmers began to write futures contracts with bankers. A futures contract helps to reduce the risk that the farmer faced from the uncertainty of the market. A banker would agree to buy a certain amount of a farmer's product at a certain time for a certain price. That price was set months or a year in advance at a rate that the farmer and banker would be comfortable with.

This transfer of risk could be beneficial to either side. Investors had the chance of making a profit if the crop was small and they bought it for a low price. Farmers had a better chance of being able to feed their families and bring in a base level of extra money.

For the first years of these contracts' existence, they were informal and sometimes speculative. They couldn't capture a wide audience of investors from many walks of life.

How It Became Mainstream

The next important step for futures and commodities trading was to find a permanent home. They received this home in the Chicago Board of Trade. The Board standardized the process of futures trading in the 1970s along with commodities trading. These instruments now had trading platforms that were trusted and standardized. Prices stabilized and buyers and sellers had more guaranteed prices.

The streamlining of this market opened it up to a much larger audience. Individuals bought and traded more stocks to fill their investment and retirement portfolio. They saw commodities and futures as a way to diversify and make more money. Hogs and wheat futures bought through the commodities market. They became attractive investments in the same vein as stocks and bonds.

What They’re Like Today

Commodities and futures markets are significantly different today. There are millions of trades that still occur every year on the trading floor in Chicago and New York.

The vast majority of trades, however, happen online. Large traders buy and sell thousands of shares in many different schemes designed to make as much money as possible. You’ll see this in a lot of long-term and short-term investments, especially in online ETF investing. Arbitration, the process by which firms use technology and skill to make small percentages off of each trade, dominate a significant part of the futures and commodities markets.

Commodities are traded more by large companies looking to hedge their stock purchases than by banks and investors working with farmers. The farmers that buy and sell futures are often large corporations that have many businesses.

Even with this diverse basis, futures contracts still serve as a way to hedge risk and bring stability to the agricultural profession.