What to know before investing in gold futures?

Gold investment has traditionally been a simple transaction involving physical possession. But over time, market evolution has brought about newer ways to invest in gold. One medium through which it can be traded is gold futures, which combine the gold market with the tenets of futures trading. 

If you are looking to invest in the gold futures, it is important to acquaint yourself with answers to some simple but important questions.

How are gold futures traded?

In India, gold futures can be traded through the BSE, NSE and MCX (Multi Commodity Exchange) in a variety of order sizes, ranging from one gram to one kilo. The buyer enters into a fixed-term contract, with an agreement to buy or sell gold at a future date for a price specified in the contract. While the contract might specify a certain amount of gold, you do not need to invest the entire amount upfront. Instead, you can put up a small percentage of the total value, known as “margin”.

Like other investments, you can either gain or lose money through a gold futures contract, depending on how the price of gold moves during the contract period. Price changes (both upwards and downwards) are measured in ticks, which is the smallest price change measured by the markets. For instance, in an MCX gold future contract, the tick size is 0.10 (or Rs. 1 per 10 grams). Thus, if you have a lot size of 1 kilo (1000 gram), your profit or loss will be Rs 100 per tick movement. You can profit from the price movement of gold during the contract period or opt for the delivery of physical gold at the end of the contract period.

What would suit your goals – a long-term or a short-term contract?

It is important to note that gold future contracts provide a hedge against price fluctuations and offer an opportunity to earn speculation profit. Businesses that engage in gold import, export, manufacturing or trading can use a gold futures contract to hedge this risk and offset potential losses in the short term. 

Ordinary investors can also use the tick movement to earn a profit. While most tend to use gold futures as a form of short-term hedging, investors looking to capitalise on the increase of gold prices in the future can set their contract for the long term, up to a year.

What kind of analysis and investment approach are you planning on implementing?

Gold futures investors can follow a fundamental approach or a technical approach towards their investments, or a combination of both. Fundamental analysis considers the gold demand-supply dynamics, current affairs and the market sentiment, as well as the economic cycle. Technical analysis relies on a more scientific approach, taking the help of pricing charts, indicators and tools like Fibonacci extensions and momentum oscillators. While fundamental approaches seek to understand the actual value of the asset, technical analysis seeks to understand price movements in the future. Gold futures investors would benefit from insights under both approaches.   

Do you understand the effect of market trends on gold futures? 

Understanding the gold market is a broad expression that includes everything that affects the gold price. As a gold futures investor, you have to keep an eye on the US dollar value, bond prices, interest rate policy of the government, and major economic decisions that stand to influence the gold price. The advent of the wedding season and agricultural patterns could also impact the gold price in India. High volume trading of gold by the central bank is another factor that can attract a reaction from the gold market. 

What kind of trading plan are you aiming to follow? 

Like equity investments, you will have to develop a bullish or bearish position and build your investment plan upon that. Besides, your operational style will also define your investment plan. You can be a scalper who enters and exits multiple times during a session. A less frequent trading style would be day trading, where you hold a position at least for the day and assess the price movement. A position trader would follow the trend rather than fluctuations, thus resulting in far less trading. No matter your position, make sure you understand why before committing to it, and that you stick to the trading plan.

Investments in gold futures can be a profitable choice, provided you have a thorough understanding of the contract and a detailed investment plan in place. Before you make any investment in gold futures, it is important you answer these questions for yourself so that you have a thorough understanding.