How to Trade Futures

If you’ve seen movies or videos with big crowds of people jumping and throwing hand signals at each other in the trading pits of an exchange, it’s time you know they are not stock traders — these are futures traders. And although trading pits are becoming a thing of the past, the popularity of futures trading has never been as high as it is now.  

Futures trading offers tremendous opportunities, but it carries high risk. If you feel like me 25 years ago, this article is the first step on your road to learning how to trade futures.

Futures Trading Terminology

If you want to learn how to trade futures and options, you need to know a few terms that will inform your decisions. Don’t enter a futures trading platform or open a brokerage account until you’ve familiarized yourself with these terms.

• Futures: Financial contracts (agreements) giving the buyer an obligation to buy an asset and the seller an obligation to sell an asset at a predetermined price on a specified day in the future. Futures are considered derivatives, meaning their price is dependent upon (derived from) an underlying asset.
• Derivatives: Financial instruments whose value is based upon a physical commodity or other financial instrument.
• Commodity: These are physical assets like wheat, grain, corn, etc. that are often involved in futures contracts.
• Liquidity: The ability to sell an investment at or near its value in a relatively short period of time.
• Futures Margin: The amount of money traders must have on hand with their broker when they open a futures position.

And before you start trading futures, make sure you familiarize yourself with the process of placing an order and the lingo associated with it.

Here are some examples of orders you can place:

• Market order is an order to buy or sell futures contracts immediately. This order guarantees that the order will be executed (filled) but does not guarantee the execution price.
• Limit order is an order to buy or sell futures contracts at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher.
• Stop order is an order to buy or sell futures contracts once the price reaches the specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order.
• Day order is an order which will expire at the end of the day (daily trading hours) if not executed.
• Good Til’ Canceled (GTC) order is an order that will remain active until executed or canceled by you.
• Market-on-Close (MOC) order is an order that will be executed at the closing price of a daily session. It can be convenient for day traders who don’t want to hold their positions overnight.

How Futures Work: The Basics

If you want to know how to trade futures for beginners, this is a good place to start. Remember, there are a few places where you can land in the market. Futures are not always a free-for-all, and they are often only as complicated as you make them. In choosing between futures vs options, remember that futures and options are traded in a similar manner, but they are quite different.

There are 2 types of futures traders: hedgers and speculators. The concept of futures started with the idea of locking in prices of commodities. It started with the hedgers, who seek stability and predictability for their businesses. If you want to learn how to trade futures, you should decide where you want to be on this seesaw.

Let’s say you are a corn farmer. You grow and sell corn. And currently, corn sells for $4.25 per bushel. But you are concerned that the prices will fall in the future (for example 6 months from now), which will decrease your profit margin. Therefore, you would like to lock in today's price. 

The best course of action is to sell short futures contracts expiring 6 months from now. Selling short essentially means a bet on the downside. If corn prices indeed drop, your business profit will decline, but the gains in the futures contracts will offset it.

On the other side of the business spectrum, a company buys corn to make food products. And it is concerned that the price of corn will increase, which will make it expensive and negatively affect the bottom line. In order to lock in today's price, it would buy corn futures contracts to offset rising prices.

While hedgers normally do not trade futures for profit and use them for business stability, speculators are there for profit. Speculators are attracted to futures due to fast price movements, liquidity and low margins. 

Speculators do not buy or sell underlying commodities or financial products. They normally close their long or short positions before the expiration and delivery dates. They are not interested in the underlying products. Their only interest is to profit from predicting futures contracts’ movements.

Whether you open a futures account or prefer to stock with trading trading, remember that you must carefully review margin rates if you plan to make massive trades, formulate an exit strategy for every position you’ve taken and remember that a cash settlement is more often than not the endgame of the futures traders.

How Futures Work: An Example

If you want to learn how to trade futures, you must remember that there a few angles you can take when trading futures contracts.

Speculators love the fact that they can control large amounts of underlying assets with relatively small amounts of money. Going back to the corn futures example, the initial margin for 1 corn futures contract is $2,025. The initial margin is the amount of money that needs to be in the account to initiate a trade in the futures market.

The maintenance margin for 1 corn futures contract is $1,500. The maintenance margin is the minimum equity that must be maintained in the account. If the equity drops below the maintenance margin, a trader must make a deposit to bring the account back up to the initial margin. 

Keep in mind that 1 corn futures contract controls 5,000 bushels. If it trades at $4.25 per bushel, it is worth $21,250 worth of corn, which means you need less than 10% to trade it. 

It’s prudent to have more money in your account to trade comfortably and avoid margin calls when you must deposit more money in your account if your trade goes against you. If you are a day trader (you close your futures position on the same day), your margin is even lower.

Exchanges determine margin rates, but your broker can adjust them. Margin is primarily based on volatility. Volatility in finance is the frequency and magnitude of price movements, up or down. The bigger and more frequent the price swings, the more volatile the market.

Here is an example of information on 1 of the most popular futures contracts, E-mini S&P 500 futures:

• Exchange: Chicago Mercantile Exchange (CME)
• Root symbol: ES
• Contracts available: Quarterly (March, June, September, December)
• Expiration dates: 3rd Friday of above-mentioned months
• Maintenance margin: $11,000
• Trading hours: Sunday through Friday 6 p.m. to 5 p.m. Eastern Time (ET) with trading halt 4:15 p.m. to 4:30 p.m.
• Contract unit: $50 x S&P 500 Index
• Minimum price fluctuation: 0.25 index points = $12.50
• You bought 1 futures contract at 3,500.00. The contract moved up to 3,510.00 (a move of 10.00 points). You are profiting $500 (10.00 x $50.00 per point).

Best Online Futures Brokers

It’s important to sign on with a trusted online broker for the best investing experience. Brokerages such as Plus500 Futures Trading offers an easy-to-use trading platform and valuable educational content.

Whether you’re looking at stock market futures, options stocks, commodity stocks, equity futures, contract financing and more. Take a look at our recommended brokers to uncover trading opportunities, engage in risk management and access several commodities markets.

Futures Products

Before you start trading futures, you must familiarize yourself with the specifications of different futures products. Futures are traded on exchanges like the Chicago Mercantile Exchange and New York Board of Trade (ICE Futures), among others. 

Futures contracts are available on numerous asset classes. The most popular categories are:

• Index futures: S&P 500, NASDAQ 100, Russell 2000, VIX, DJIA, foreign indexes
• Interest rate futures: treasuries (2-, 5-, 10-, 20-year, euro
• Currency futures:  currencies and currency spreads
• Grains futures: wheat, corn, soybeans, rice
• Metal futures: gold, silver, copper, platinum
• Energy futures: crude oil, heating oil, gasoline, natural gas
• Softs futures: cotton, cocoa, coffee, sugar, orange juice
• Livestock futures: cattle, lean hog, pork bellies

All the necessary information is available on their websites as well as your broker’s website. It’s a good idea to speak with your broker to confirm that information.

Futures Trading Strategies

Some traders (speculators) specialize in 1 or 2 futures sectors simply because they have an edge and understanding of those markets' fundamentals and economic trends. Others trade all or most of them because they view them as nothing more than charts and approach them with technical analysis.

The technical approach is analyzing futures based on chart patterns and sentiment. Both strategies have merit, but you need to decide which avenue you prefer to take as you learn how to trade futures. The market price is just the beginning of understanding futures and how commodity markets can serve your portfolio.

Short term traders tend to trade the most liquid contracts, usually front month contracts (contracts which are close to expiration). They are alright taking on some price risk, but they are also willing to move out of a position if a price change is a bit too steep for their liking.

The most common strategy in futures trading is a directional strategy where a trader bets on the direction of a certain commodity or a financial instrument. They either buy (going long) and sell (going short) depending on whether they expect prices to rise or fall. 

A more complex approach involves spread trading. Spread trading may involve going long March crude oil futures contract and simultaneously going short June crude oil contract. That is a good strategy if a trader perceives the March contract as being undervalued compared to the June contract. This trader seeks to benefit from a contraction of a spread regardless of the absolute direction of crude oil. This is a bet on a spread.

Another example of spread trading is a spread between 2 correlated markets. Correlation means when two or more markets tend to move in the same direction. A good example would be to go long S&P futures and simultaneously go short NASDAQ futures if a trader thinks S&P is undervalued compared to NASDAQ.

Keep in mind that spread strategies are no less risky than directional strategies. A spread can go against you as much as a directional trade, meaning that a commodities trading strategy is only as good as the market will allow. Be prepared to change your strategy if the market is no longer cooperating.

There are several factors which should be taken under consideration while choosing if investing in futures is right for you:

Pros of Futures Investing

• Potential for high returns: Futures investing allows investors to leverage their capital and potentially earn higher returns compared to traditional investments.
• Diversification: Futures contracts cover a wide range of asset classes, including commodities, currencies, and financial instruments, allowing investors to diversify their portfolios and spread risk.
• Hedging: Futures contracts can be used as a hedging tool to protect against price fluctuations in underlying assets. This helps investors mitigate potential losses and manage risk.
• Liquidity: Futures markets are highly liquid, meaning investors can easily buy or sell contracts without impacting the market price. This provides flexibility and ensures that investors can enter or exit positions as needed.
• Lower transaction costs: Futures trading typically involves lower transaction costs compared to other investment options, such as stocks or options. This makes it more accessible to a wider range of investors.

Cons of Futures Investing

• High risk: Futures investing involves a significant amount of risk due to leverage. While leverage can amplify potential gains, it can also lead to substantial losses if the market moves against the investor's position.
• Volatility: Futures markets can be highly volatile, with prices fluctuating rapidly. This volatility can lead to unpredictable and sudden changes in investment values.
• Complex instruments: Futures contracts can be complex and require a deep understanding of the underlying assets and market dynamics. This complexity can make futures investing challenging for inexperienced investors.
• Margin calls: Futures trading requires investors to maintain a certain level of margin in their accounts. If the account falls below the required margin level, investors may receive a margin call, requiring them to deposit additional funds or close positions.
• Market manipulation: Futures markets can be susceptible to market manipulation, as large institutional investors or traders can influence prices through their trading activities. This can create an uneven playing field for individual investors.

Open a Futures Trading Account and Trade Futures Today

Futures are highly leveraged (margined) instruments, which makes them appealing and risky at the same time. Most traders recommend learning and using technical analysis for futures trading. 

Get comfortable with some of the futures markets, and start small. All you need is a few thousand dollars, a reputable broker and the ability to control your emotions.

Frequently Asked Questions