How you can Trade Futures: Platforms, Strategies, and Pros and Cons

Investors can trade futures to take a position or hedge on the worth direction of a security, commodity, or financial instrument. To do that, traders purchase a futures contract, which is a legal agreement to purchase or sell an asset at a predetermined price at a specified time in the longer term.

Futures got here about within the mid-Nineteenth century, allowing grain farmers to sell their wheat for forward delivery. Futures trading provides investors with a quick and cost-effective technique of accessing global financial and commodity markets.

Key Takeaways

  • Investors can trade futures to take a position or hedge on the worth direction of a security, commodity, or financial instrument.
  • A futures contract is a financial instrument through which a buyer and seller conform to transact an asset at a hard and fast price at a future date.
  • Key futures markets include stock indexes, energy, currencies, cryptocurrencies, rates of interest, grains, forestry, and livestock.
  • Key benefits of futures trading include access to leverage, diversification, and hedging, while overleverage and managing expiry dates present potential challenges.
  • A futures trading platform must be intuitive to make use of, offer multiple order types, and have competitive fees and commissions.
  • A basic futures trading plan should include entry and exit strategies in addition to risk management rules.

Basics of Futures Trading

As its name suggests, a futures contract is a financial instrument through which a buyer and seller conform to transact an asset at a hard and fast price at a future date. Despite a futures contract providing the chance for the delivery of an asset, most don’t lead to physical delivery but are somewhat utilized by investors to take a position on a security’s price or hedge risk in a portfolio.

Traders can speculate on a big selection of securities and commodities by trading futures. Key futures markets include stock indexes, energy, currencies, cryptocurrencies, rates of interest, grains, forests, and livestock.

Most futures contracts are traded through centralized exchanges just like the Chicago Board of Trade and the Chicago Mercantile Exchange (CME). Many cryptocurrency brokers, reminiscent of Binance, offer perpetual futures—a contract without an expiry date—allowing traders not to fret about an expiry month.

Benefits of Futures Trading

Leverage

Leverage is an investment strategy of using borrowed money—specifically, the use of varied financial instruments or borrowed capital—to extend the potential return of an investment. Futures are traded with leverage on margin, allowing investors to regulate larger positions with a small initial outlay. Nevertheless, this generally is a double-edged sword if the asset’s price moves within the unintended direction. Traders must be aware they’ll lose greater than their initial margin when trading futures contracts.

Diversification

Investors can trade futures on every thing from stock indexes to orange juice, helping to supply a diversified portfolio across multiple asset classes.

After-Hours Trading

Futures allow traders to reap the benefits of opportunities nearly across the clock. For instance, a trader might need to go to long futures contracts on the Nasdaq 100 Index if several mega-cap technology stocks report higher than expected earnings after the market close.

Hedging

Investors can use futures to guard unrealized profits or minimize potential losses. The good selection of futures products available allows traders to take a cheap hedge against the broader market or specific sectors and individual commodities.

Disadvantages of Futures Trading

Over-Leverage

Leverage is a double-edged sword. On the one hand, it could possibly be advantageous to amplify returns with less of a money outlay. Nevertheless, if markets turn against you, you can be answerable for the complete amounts of the losses and be subject to margin calls. In other words, leverage may also amplify losses.

Managing Expiry Dates

Most futures contracts have an expiry date that traders need to watch. Because the contract approaches its expiry, its price may rapidly lose value and even develop into worthless. To combat this, investors often roll forward their futures contract to a longer-dated one because the expiry date approaches.

Pros and Cons of Futures Trading

Choosing a Futures Trading Platform

When choosing a futures trading platform, investors should be certain that it’s intuitive to make use of, offers multiple order types to assist with risk management, and has competitive fees and commissions.

More advanced traders may need a platform that gives application programming interface (API) access to permit algorithmic trading functionality. Lively traders should select a futures platform with a mobile trading app that allows you to execute trades and manage positions on the go.

Today, most full-service online brokerages and trading platforms have access to futures trading. You’ll need to request and be granted approval to start trading these markets.

Developing a Futures Trading Plan

As with trading stocks or other financial assets, it is important that investors develop a plan for trading futures that outlines entry and exit strategies in addition to risk management rules. For instance, if a trader uses technical evaluation to locate entries, they could determine to open a protracted futures trade on a golden cross signal—when the 50-day easy moving average (SMA) crosses above the 200-day easy moving average. The trading plan could also include a stop-loss order placed 5% below the entry price to administer downside risk.

Alternatively, a futures trading plan centered around fundamental evaluation might generate buy or sell signals based on crop or energy inventory reports. As an illustration, a trader may short an oil futures contract if weekly oil inventories grow at a faster pace than analysts had expected. After all, some traders may incorporate each technical and fundamental evaluation into their futures trading plan.

Generally, there are three futures trading plans:

  • Long: buy futures and profit when the costs increase
  • Short: sell futures contracts and profit when the costs decrease
  • Spread: concurrently buy different futures contracts and profit when the relative price difference widens (or narrows). These will be on the identical underlying but using different expiration dates, or on futures in two closely-related products like crude oil and gasoline.

Technical evaluation is a trading discipline employed to judge investments and discover trading opportunities by analyzing statistical trends gathered from trading activity, reminiscent of price movement and volume.

Contract Specifications

Before trading futures, investors have to know several key elements about futures contracts to assist determine position size and manage risk. These include contract size, contract value, and tick size. We’ll use the favored E-mini S&P 500 futures contract offered by the CME for example.

Contract Size

As its name suggests, contract size refers back to the deliverable quality of the asset that underlies the futures contract. For instance, the E-mini S&P 500 is $50 times the worth of the S&P 500 index.

Contract Value

Investors calculate the contract value by simply multiplying the contract size by the present price. For example a trader holds one contract of the E-mini S&P 500, and the underlying index is trading at $4,800. This implies the contract value equals $240,000 ($50 x $4,800).

Tick Size

Tick size refers back to the minimum price change of a futures contract. In other words, the least amount that the worth of a selected contract can fluctuate. As an illustration, the E-mini S&P 500 has a tick size equal to one-quarter of an index point. As one index point equals $50 within the E-mini, one tick is the equivalent of $12.50 ($50/4).

Futures Markets You Can Trade in

Futures contracts are listed on several different products comprising many various asset classes. Amongst the preferred include:

  • Equity indexes: e.g., the S&P 500 or Nasdaq 100
  • Hard commodities: precious metals
  • Soft commodities: agricultural products like livestock or crops
  • Energy: crude oil, natural gas
  • Currencies: pairs like EUR/USD or GBP/JPY
  • Treasuries: U.S. government bonds and rates
  • Crypto: Bitcoin, Ether

Putting It All Together

Let’s put all of it together in a trading example using the E-mini S&P 500 futures. The S&P 500 index recently broke out to a brand new all-time high, and we might wish to fade the move, hoping to book profits on a retracement to the initial breakout area around $4,720. Our money management rules stipulate that we risk not more than 1% of our futures trading account on anyone trade. Moreover, our broker requires a margin of $12,000.

Due to this fact, we determine to open a brief position, trading one contract and managing risk by placing a stop-loss $25, or 100 ticks, above our entry price at $4,786. As we’re risking $1,250 ($12.50 per tick x 100), we should always have not less than $125,000 in our futures trading account to fulfill the 1% risk per trade rule ($1,250 = 1% of $125,000). Ideally, we should always have more in our account to cover the $12,000 margin requirement and guard against margin calls if the worth of the S&P 500 moves against us.

We then place a take-profit order on the initial breakout area at $4,720—264 ticks, or $66, below our entry price. If the market moves in our favor and hits the order, we make a profit of $3,300 ($12.50 per tick x 264).

Conversely, we incur a $1,250 loss if we get stopped out. In any case, the longer term trade offers a good risk/reward ratio of 1:2.64 ($1,250 risk per contract versus $3,300 reward per contract).


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What Assets Can Be Traded Using Futures?

Investors can trade futures on stock indexes, energy, currencies, cryptocurrencies, rates of interest, grains, forestry, and livestock.

What Are the Key Benefits and Disadvantages of Trading Futures?

Benefits include leverage, diversification, trading after hours, and hedging. Disadvantages include over-leverage and managing expiry dates.

What Should I Look Out for When Choosing a Futures Trading Platform?

Traders should select a futures trading platform that’s intuitive to make use of, offers multiple order types, and has competitive fees and commissions.

What Are Some Basics to Include in a Futures Trading Plan?

When developing a futures trading plan, traders should include entry and exit strategies and basic risk management rules.

The Bottom Line

Futures are derivative contracts that allow you speculate on the longer term price of some asset or commodity, or to allow you to hedge against existing positions. Because they utilize leverage, futures can amplify your bets, making for larger returns, but additionally larger losses.

Futures even have expiration dates, so you might want to watch out to roll over or close out positions so to not be stuck with physical delivery of unwanted commodities. To start out trading futures, you have to to seek out a brokerage that gives access to those markets after which get approval.

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