Futures trading is a financial strategy that allows you to buy or sell a specific asset at a predetermined price at a specified time in the future. It’s a way to potentially profit from the price movements of commodities, stocks, and other assets. This guide aims to break down the complexities of futures trading, making it accessible for beginners.
You should read this article because it demystifies the complexities of futures trading, offering actionable insights for both beginners and seasoned traders.
I’ll answer the following questions:
- What are futures in financial trading?
- How does futures trading work?
- What are the benefits of trading in futures?
- What risks are associated with futures trading?
- What types of futures contracts are available?
- What key concepts should you know before trading futures?
- What strategies can you employ for successful futures trading?
- What are the initial and maintenance margins in futures trading?
Let’s get to the content!
Table of Contents
- 1 What Are Futures?
- 2 What Is Futures Trading?
- 2.1 How Does Futures Trading Work?
- 3 Benefits of Futures Trading
- 3.1 Leverage
- 3.2 Hedging
- 3.3 Liquidity
- 3.4 Diversification
- 3.5 Price Discovery
- 3.6 24-Hour Trading
- 3.7 Standardized Contracts
- 3.8 Transparent Trading
- 4 Risks of Futures Trading
- 4.1 Leverage Risk
- 4.2 Market Volatility
- 4.3 Liquidity Risk
- 4.4 Systemic Risk
- 4.5 Regulatory Changes
- 5 Types of Futures Contracts
- 5.1 Commodity Futures
- 5.2 Financial Futures
- 5.3 Individual Stock Futures (Single Stock Futures)
- 6 Things You Need To Know Before Trading Futures
- 6.1 Expiration Date
- 6.2 Current Price
- 6.3 Initial Margin and Maintenance Margin
- 6.4 Settlement Price and Delivery Date
- 7 Strategies for Successful Trading in the Futures Market
- 7.1 Understand How Futures Work
- 7.2 Choose a Futures Contract Type and Market to Trade in
- 7.3 Choose Your Investing Strategy
- 7.4 Place Your Futures Trade and Manage It
- 8 Key Takeaways
- 9 FAQs
- 9.1 What Is Required for Trading Futures?
- 9.2 Can I Trade Futures with $100?
- 9.3 What Are Futures Contracts?
- 9.4 What Are Common Financial Instruments in Futures Trading?
- 9.5 Where Can I Find Reliable Information for Futures Trading?
- 9.6 What Are the Basic Transaction Elements in Futures Trading?
- 9.7 How Do Ratings and Reviews Impact a Trader’s Choice of Broker?
- 9.8 Is Futures Trading a Global Business?
- 9.9 Do I Need to Know English for Futures Trading?
- 9.10 How Do Funds and Value Interact in Futures Trading?
- 9.11 What Role Do IPOs and Shares Play in the Stock Market for Futures Traders?
What Are Futures?
Futures are financial contracts obligating the buyer to purchase, and the seller to sell, an asset at a predetermined future date and price. They are standardized contracts traded on futures exchanges. In my years of trading and teaching, I’ve found that understanding the basic structure of futures is crucial for anyone looking to dive into this market.
What Is Futures Trading?
Futures trading involves buying and selling futures contracts with the aim of making a profit. Unlike trading stocks or ETFs, you’re not buying ownership in a company; you’re entering a contract with specific terms.
How Does Futures Trading Work?
In futures trading, you’ll enter into a contract to buy or sell a specific quantity of an asset at a predetermined price on a set date. You can either hold the contract until its expiration or sell it before to lock in profits or cut losses.
Benefits of Futures Trading
Futures trading offers several advantages, including leverage and the ability to hedge against market risks. These benefits make it a versatile tool in a trader’s arsenal.
You can’t trade futures with a cash account… but that isn’t necessarily a bad thing. A cash account prevents you from falling into the debt trap that leverage in a margin account can sometimes create. To understand the pros and cons of trading in a cash account, you can read more about it here.
To make an informed decision on whether a cash or margin account is right for you, check out this comprehensive guide.
Leverage
Leverage allows you to control a large position with a relatively small amount of money. This amplifies both potential profits and potential losses, so it’s crucial to manage risk effectively.
Hedging
Hedging is the practice of entering into a futures contract to offset potential losses in other investment positions. It’s a risk management strategy that can protect your portfolio from adverse market movements.
Liquidity
Futures markets are generally very liquid, meaning there are plenty of buyers and sellers. This liquidity makes it easier to enter and exit positions, which is particularly beneficial for short-term traders.
Diversification
Futures allow you to diversify your portfolio by trading in different markets, from commodities like oil and gold to financial instruments like bonds and currency.
Price Discovery
Futures markets play a vital role in price discovery, which is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers.
24-Hour Trading
One of the advantages of futures trading is that these markets are usually open 24 hours a day, providing more opportunities to trade.
Standardized Contracts
Futures contracts are standardized, meaning they have set quantities, expiration dates, and other terms. This standardization makes it easier to trade and provides a level of transparency.
Transparent Trading
Futures trading is conducted through centralized exchanges, providing a transparent and regulated environment. This transparency helps to build trust and allows for fair trading.
Risks of Futures Trading
While futures trading offers various benefits, it’s not without risks. Understanding these risks is essential for both new and experienced traders.
Leverage Risk
While leverage can amplify profits, it can also magnify losses. If the market moves against your position, you could lose more than your initial investment.
Market Volatility
Futures markets can be highly volatile, with prices subject to rapid and unpredictable movements. This volatility can be both an opportunity and a risk.
Liquidity Risk
Though generally liquid, some futures contracts can suffer from low liquidity, making it difficult to enter or exit positions.
Systemic Risk
Systemic risk is the possibility that an event at the company or market level could cause instability or collapse in the broader financial system.
Regulatory Changes
Changes in regulations can impact futures markets. Being aware of current and upcoming regulations can help you adapt your trading strategies accordingly.
Types of Futures Contracts
There are various types of futures contracts, each with its own set of characteristics and risks. Knowing the types of contracts can help you choose the right one for your trading strategy.
Apart from traditional commodity and financial futures, you can also consider ETFs that track these assets. ETFs offer a way to engage in futures trading without having to deal with expirations or the complexities of the futures market. They can be a good starting point for beginners or a diversification tool for seasoned traders. To explore the best ETFs suitable for day trading, you can read this detailed article.
Commodity Futures
Commodity futures contracts involve the buying or selling of a commodity like oil, gold, or agricultural products. These are the most traditional forms of futures contracts.
Financial Futures
Financial futures are contracts related to financial instruments like currencies, bonds, or stock indices. They are often used for hedging or speculation.
Individual Stock Futures (Single Stock Futures)
Individual stock futures, or single stock futures, are contracts based on individual stocks. They offer a way to profit from the price movements of specific companies.
Things You Need To Know Before Trading Futures
Before diving into futures trading, there are several key concepts you need to understand. These include the expiration date of the contract, the current price, and the initial and maintenance margins.
Expiration Date
Each futures contract has an expiration date, which is the date when the contract must be settled. You can either close out the position before this date or let the contract expire and settle it as specified.
Current Price
The current price of a futures contract is determined by supply and demand factors in the marketplace. It’s essential to monitor these prices closely as they will impact your trading decisions.
Initial Margin and Maintenance Margin
The initial margin is the amount of money you need to open a futures position. The maintenance margin is the minimum amount that must be maintained in your account to keep the position open.
Settlement Price and Delivery Date
The settlement price is the price used for determining profit or loss for the day, as well as margin requirements. The delivery date is the date when the underlying asset must be delivered to fulfill the contract.
Strategies for Successful Trading in the Futures Market
Success in futures trading doesn’t come from luck; it comes from understanding the market and implementing sound trading strategies.
Understand How Futures Work
The first step in developing a trading strategy is to understand how futures work. This includes understanding the terms of the contracts, how they are priced, and how they are traded.
Choose a Futures Contract Type and Market to Trade in
Different futures contracts have different risk profiles and potential returns. Choose a contract type and market that aligns with your trading goals and risk tolerance.
Choose Your Investing Strategy
Your investing strategy should be based on your risk tolerance, time horizon, and financial goals. Whether you’re looking to hedge your portfolio or speculate on price movements, your strategy should be tailored to meet these objectives.
Place Your Futures Trade and Manage It
Once you’ve chosen a strategy, the next step is to place your trade. This involves choosing the right type of order, setting your entry and exit points, and managing your risk.
Key Takeaways
Futures trading offers a range of opportunities but also comes with significant risks. Understanding these risks and how to manage them is crucial for success in the futures market.
There are a ton of ways to build day trading careers… But all of them start with the basics.
Before you even think about becoming profitable, you’ll need to build a solid foundation. That’s what I help my students do every day — scanning the market, outlining trading plans, and answering any questions that come up.
You can check out the NO-COST webinar here for a closer look at how profitable traders go about preparing for the trading day!
Have you attempted futures trading — or do you want to in the future? Let me know in the comments!
FAQs
Futures trading can seem complex, but understanding the basics can go a long way in helping you become a successful trader.
What Is Required for Trading Futures?
To trade futures, you’ll need a brokerage account that allows futures trading. You’ll also need sufficient capital to meet the initial margin requirements.
Can I Trade Futures with $100?
Trading futures with $100 is generally not feasible due to the high margin requirements and the risks involved.
What Are Futures Contracts?
Futures contracts are standardized agreements to buy or sell an asset at a predetermined price at a specified time in the future.
What Are Common Financial Instruments in Futures Trading?
Futures trading often includes a variety of financial instruments. For example, you can trade commodity futures such as energy or financial instruments like cds and forex. These instruments are usually traded on exchanges like the Nasdaq or other platforms linked to Wall Street.
Where Can I Find Reliable Information for Futures Trading?
Reliable information for futures trading can often be found in reviews, research articles, and books. It’s important to seek advice from multiple sources, including both online reviews and published books to make well-informed decisions.
What Are the Basic Transaction Elements in Futures Trading?
In futures trading, transactions are typically initiated with orders that are placed through brokers. These orders rely on a business of investors who provide the liquidity needed for trading. Accurate data is crucial for making informed trading decisions.
How Do Ratings and Reviews Impact a Trader’s Choice of Broker?
Ratings and reviews can significantly impact a trader’s choice of broker for futures trading. Investors often look at pages containing items like broker ratings, user reviews, and additional information to guide their decisions.
Is Futures Trading a Global Business?
Yes, futures trading is a global business. It’s not limited to Wall Street or the Nasdaq in the United States but extends to exchanges and brokers around the world. Location can be a key factor, especially for traders dealing in forex or international commodities.
Do I Need to Know English for Futures Trading?
While futures trading is a global business, English is often the primary language used for research articles, books, and brokers’ platforms. Being proficient in English can give you access to a lot of valuable information and advice in this field.
How Do Funds and Value Interact in Futures Trading?
In futures trading, the value of your positions can significantly affect the funds you have in your trading account. For example, if you are trading options or shares, the market value of these financial instruments can either increase or decrease, affecting the overall funds you have at your disposal for future trades.
Initial Public Offerings (IPOs) and shares are integral components of the stock market. For futures traders, these can provide opportunities for speculative trades or hedging strategies. For instance, options contracts might be available for shares of a company that recently had an IPO, offering new avenues for investment and risk management. The author of your trading guide or research article might have detailed insights into how to navigate such scenarios.
