Backwardation
Candlefocus EditorIn a normal condition, the price of the underlying asset and the futures markets will tend to have the same price, as long as there are no restrictions on short selling of the underlying asset by speculators. In a case of backwardation, investors and traders can benefit from the discrepancy between the current price of the asset and the future contract price by utilizing a strategy of selling assets at the current price and then buying assets at the lower futures price when that contract expires. This technique of buying low and selling high allows traders to collect a profit in a relatively short period of time.
It is important for investors to understand the factors that can cause backwardation in the markets. Generally, backwardation is observed when there is a high demand for an immediate possession of the asset and the anticipated demand for the asset declines in the future months. Furthermore, there may be restrictions on short selling which may also increase the current price as compared to the future contract prices.
Although backwardation is a normal phenomenon in a number of financial markets, it usually indicates a bearish bias of the market. Therefore, investors and traders need to be aware of the risks that may be involved when entering into a strategy of buying and selling in the futures markets. It is advisable to seek the advice of a financial advisor or a qualified professional before engaging in this type of trading.
Overall, backwardation is an important market indicator which can be utilized by savvy investors and traders to generate attractive returns in a relatively short time frame. This phenomenon is usually observed in situations where there is a high demand for an immediate possession of an asset and the anticipated demand is declining in the future. Therefore, understanding the fundamentals of backwardation is essential for making smart and profitable decisions in the financial markets.