What can futures trading do for you? If you want to manage risk or ride market trends then futures trading is an option. This guide will help you understand futures markets and how to develop trading strategies and manage risk.
Learn how to use futures in your investment approach and how they compare to stocks or options – all in plain English. For beginners and experts alike this article will get you futures markets savvy and ready to trade.
Summary
- Futures contracts are agreements to buy or sell assets at a set price on a set date, used for hedging and speculating and have standard contract details such as quantity, delivery date, location and asset quality.
- Trading futures involves choosing a reputable brokerage firm, understanding margin requirements and leverage, placing orders through trading platforms or directly and using risk management strategies like position management and stop-loss orders.
- Futures trading strategies are hedging for risk management, speculating to profit from price moves and spread trading to profit from price differences. Technical and fundamental analysis is key to forecasting market moves.
What are Futures
Futures contracts are the building blocks of futures trading. These legal agreements obligate a buyer to buy and a seller to sell an asset at a set price on a set date in the future.
But why enter into such binding agreements? The main purposes of these contracts are two-fold: speculation and hedging, both used to navigate price movements in financial markets.
Every futures contract is customised while being standardised for exchange traded products by specifying:
- quantity of underlying asset
- delivery date
- delivery location
- asset quality
This standardisation allows for orderly and consistent transactions across all trades. Within this broad landscape there are two main types of traders: hedgers who want to lock in a price and reduce risk and speculators who want to profit from price moves in the underlying asset.
In short, every participant in futures exchanges is either a risk manager – like a sailor bracing for rough seas. Or an opportunity seeker – like a sailor waiting for the wind in their favour to take them to profit.
Types of Futures
There are many types of futures contracts covering many assets. For those interested in:
- Energy
- Metals
- Currencies
and other financial products.
There’s a futures contract to suit your trading goals. Imagine walking into a market that has everything.
Among the most popular types of these contracts you’ll find:
- Agricultural products
- Energy
- Metals
And for currency and index traders there’s currency futures and equity index products.
From maize kernels to barrels of crude oil, gold bars to government bonds, or from euros to e-mini S&P indexes. The world’s futures markets offer plenty of opportunities for hedgers and speculators – each affected differently by interest rates across this complex landscape.
Glossary
It’s important to understand some key terms of the futures market and how to trade it. One of them is the “initial margin” which is a portion of your initial investment required to enter into futures contracts.
This is different from a normal transaction where you pay the full contract value upfront. With futures you only need to cover the initial margin – like paying a deposit for a holiday package.
It’s also important to understand the characteristics of the futures contracts offered by brokers, such as how much each point move is in dollar terms and what’s a big move in the contract.
Like other types of future agreements, stock futures contracts have expiration dates and are month based – like checking the expiry date on perishable goods, so too should you keep track of the expiry date of your purchased or held future contract positions.
How to Trade Futures
Trading futures is like building a machine. It requires careful planning and understanding of many components which include:
- Choosing a broker you can trust
- Assessing how easy to use the services and tools of the broker as these will affect your trading when trading futures
- Placing trades either through online platform or directly with the broker
Managing open positions in the market is an important part of trading futures. Like a ship captain navigating through rough seas, traders monitor and adjust their existing contracts in the market.
To reduce risks they may roll over contracts into new periods. But what to do during market uncertainty? This is where clearinghouses come in – they act as an intermediary for every transaction to ensure all parties fulfill their obligations under the futures contract and mitigate default risks.
Choosing a Broker
Choosing a futures broker to trade with requires the same level of care as choosing a partner. This firm should earn your trust, align with your trading goals and provide you with the tools to succeed.
What’s important here is an advanced trading platform – one that has robust research capabilities, customizable trade options and real time market monitoring – so it’s fast and user friendly.
When trading futures with a broker, check their fee structure to ensure transparency and value for money. Other important factors are the firm’s reputation in the market, fast trade execution and good customer support.
Since futures trading is a big financial commitment, you want to be sure your chosen broker treats your investment as much as you do.
Placing Orders with a Futures Trading Platform
Once you have chosen a broker, the next step is to place your order, like booking a table at your favorite restaurant – this can be done online or by contacting the establishment directly. Just like ordering futures contracts can be done on an online futures trading platform or by contacting your chosen broker directly.
Before placing an order in the futures market, traders must decide on several important details such as which contract to trade and its expiration date, whether to buy or sell and how many contracts to trade.
And set their target price for this trade. Traders can use different types of orders when trading futures – market orders that execute at current price, limit orders that sets boundaries on buy/sell price and stop orders that triggers trade once certain conditions are met.
Position Management
Managing a position in the futures market requires forward thinking and monitoring of market conditions. As the expiration date of a futures contract approaches, traders often roll over their positions to the next contract month to maintain their position in the market.
Traders can use One-Triggers-Other (OTO) orders which triggers a stop order after the initial order is executed. This way you can manage risk without having to constantly monitor the market.
By having a trading plan that outlines profit targets and exit strategies, traders can reduce impromptu decisions and be more efficient in managing positions in the futures contracts.
Futures Trading Strategies
A chess grandmaster plans every move, a futures trader must have a detailed trading strategy. This means setting profit targets and exit plans for the trades. But mastering futures trade goes beyond planning. It requires being adaptable to market changes.
By being able to go long and short in the market, traders can trade more opportunities. Focusing on fewer markets can help you be an expert in one area and focused.
Spreading trades across different areas can also bring benefits like diversifying an investment portfolio. But remember, successful futures trading is more like a marathon than a sprint – consistency and discipline are often the key to success.
Hedging
Hedging is a risk management technique. This helps to balance positions and reduce exposure to price fluctuations and market volatility.
For example, if you’re a farmer growing wheat, you can lock in your income by trading through a futures contract that fixes the selling price of your crop at a agreed price on a specific date in the future.
To hedge effectively you need to choose the right type of futures contract, determine the right hedge ratio and use strategies like forward hedging or cross hedging.
These are risk management techniques. Note that while hedges can protect against price declines, there are imperfections because of how stock portfolios are aligned with indices used for futures trading. This protection often requires giving up some gains for reduced risk.
Speculation
Speculation is about taking risk, whereas hedges are about managing it. Speculators are like adventurers who seek gains from price movements of underlying assets. They buy or sell futures contracts based on their forecast of price movements. A speculator who thinks oil prices will go up would buy oil futures.
When the price of the asset goes above the contract price at maturity, these speculative actions can be profitable if the forecast is correct.
Conversely, investors can go short when they think the value of the underlying asset will go down and profit from the decline. Remember that while there are profitable opportunities in speculation, it also comes with big risks.
Spread Trading
Futures traders often do spread trading which is buying and selling two correlated futures contracts at the same time to take advantage of the price difference. This is like buying apples from a farmer at a discounted price and then selling them to the community market at a higher price.
There are several types of spread trading. For example, calendar spreads is buying and selling futures with different delivery months, usually with the expectation that the contract prices will converge over time. Pairs trading is opening positions in two different futures instruments based on the forecast that their prices will move opposite to each other.
Risks and Rewards of Futures Trading
Futures trading has big rewards and big risks like other financial instruments.
The leverage in futures trading can multiply gains and losses when the market moves. It’s like driving at high speed. You can reach your destination faster but there’s a higher chance of accidents.
Traders may receive margin calls for more capital if the market is against them which can lead to big financial losses. Sudden price movements in the futures market due to big economic events reminds us to have strong risk management strategies.
Compared to stock investments, trading in futures contracts involves more risk because these contracts have elements of high leverage and daily settlement volatility in traders’ futures accounts.
Leverage and Margin Trading
Margin trading and leverage are two important concepts that affect your outcome. Leverage is made possible by low margin requirements compared to the total value of the contract so you can control a big contract with a small initial capital and no need for loan. This is like steering a big ship with a small rudder.
Leverage is a powerful tool in trading. It has risks that must be considered. While leveraging can multiply gains, it can also multiply losses.
If the market moves against you, you may be required to add more capital to meet margin call.
Unlike direct stock investments where full payment is required upfront, futures contracts only require investors to pay part of the cost upfront as initial margin. Also note that your losses can exceed the initial margin amount and may require additional cash injection.
Risk Management Techniques
Risk management is important. To manage risk, stop-loss orders are more effective than mental stops, a protective barrier against financial loss.
Along with stop-loss orders, bracket orders is also important in managing trading positions in futures markets. It helps traders control their emotions and overall risk management. Indeed, success in futures trading is not just about making profits but also about controlling losses.
Technical and Fundamental Analysis for Futures Trading
Futures trading requires traders to use two types of analysis: technical and fundamental.
Technical analysis is the study of historical market data especially price and volume to forecast future price trends. This is like using historical climate patterns to forecast the weather.
Fundamental analysis is focused on economic variables that can affect the value of the underlying asset of the futures contract. It looks at supply-demand balance, geopolitical events and change in government regulations – like projecting the economic direction of a country by looking at its current economic data and policy environment.
Technical Analysis Tools
Several tools are used in technical analysis to analyze market trends and make trading decisions. One is charts, which is a visual representation of price movement over time. Reading a chart is like reading a map – it shows you where you’ve been and can guide you where to go.
Another important tool in technical analysis are technical indicators. These include moving averages, momentum oscillators and relative strength index (RSI). These indicators are quantitative ways to analyze market trends and make trading decisions. They are like compasses, helping traders navigate the market’s rough seas.
Fundamental Analysis Factors
Market participants analyze several factors in fundamental analysis. These include supply and demand balance which determines the market price of commodities or financial instruments at the point where they are equal. This is like natural selection – only the strongest survive.
Traders look at critical elements in their analysis including geopolitical events, weather patterns and economic data releases. All these can move commodity prices.
For example, conflict in an oil producing country can disrupt its oil flow and cause prices to go up. A bumper crop can increase supply of farm products and cause commodity prices to go down.
Futures Trading vs Other Financial Instruments
Futures markets has its own advantages and risks compared to other financial instruments, allows trading for almost the entire day.
This extends the trading window beyond traditional stock market hours, giving traders from different time zones more flexibility. Unlike equities which are ownership stakes in companies, futures contracts is a formal agreement that specifies the terms under which an asset will be bought or sold at a certain price on a specific date.
If you want to take advantage of these futures opportunities, opening a dedicated futures account is often a good idea.
On the other side of the coin, futures trading involves leverage, a tool that allows traders to control big positions with a small amount of actual capital, thus amplifying both profits and losses compared to direct equity where full position size is determined by the amount of capital.
So while it can give higher gains than stock trades, those who are willing to take calculated risk must also know that futures trading can introduce more risk as well.
Futures vs Stocks
Trading futures instead of stocks gives you higher leverage and more trading hours. Futures contracts unlike stocks which reflects ownership of a company with potential value growth, are agreements that specifies the terms to buy or sell an asset at a certain price on a specific date. This allows you to profit from market movements in either direction in the futures market.
Futures contracts are usually short term focused since they expire within a year. Unlike equity where the outlook is usually long term.
Since futures trading involves more leverage, both gains and losses can be bigger compared to stock trading – introducing more risk. So while there’s big earning potential in futures trades, it also requires good risk management.
Futures vs Options
Futures contracts unlike stocks and options requires the buyer to take delivery of the underlying asset when it expires. Options on the other hand gives the holder the choice to buy or sell the asset before it expires without any obligation.
In options trading, buyers can limit their losses to the option premium paid – a risk management strategy. In futures trading, contracts binds both parties to fulfill the contract terms.
So big losses can happen if market conditions turn against you. While it offers big gains, futures trading is riskier than options trading.
Conclusion
We have covered the basics to advanced concepts. Futures contracts is a way to hedge against price fluctuations or speculate on the future value of an asset.
We’ve covered how to trade futures from choosing a brokerage firm to placing orders to position management. We’ve also discussed the different strategies in trading futures like hedging, speculation and spread trading. We’ve also compared this to other financial instruments like stocks and options. Now you have the knowledge, you can start your futures trading journey.
FAQs
Is futures trading good for beginners?
Futures trading is a type of futures trading. Not recommended for those who are just starting out as it requires a lot of time and effort to analyze charts, read financial news and stay updated.
Is futures trading profitable?
Futures trading can be profitable when you forecast price movements correctly. There’s a lot of risk involved and many individual traders lose.
When trading futures, you must carefully think through your strategy and how much risk you’re willing to take.
Can I trade futures with $100?
Yes, you can trade futures with $100. Just be aware of the risks involved since futures markets are unpredictable. While you can start trading with that amount, you must manage this investment carefully.
How does futures trading work?
Futures trading is securing the current market price of an underlying asset as a fixed price for a future trade. This allows traders to hedge or speculate on the future value of various assets, big gains and big risk.
What is a futures contract?
A futures contract is a contractual agreement that obliges the buyer to buy or sell an underlying asset at a fixed price on a specific date in the future. This is used as a risk management strategy or to speculate on the price fluctuations of the asset.