Futures Trading: A Guide To Making Smart Investment Choices

Futures are a type of financial contract that allows investors to speculate on the future price of an asset or commodity, or to hedge against existing positions. They are a form of derivative, meaning their value is based on the performance of an underlying asset.

A futures contract is an agreement for the buyer to purchase, and the seller to sell, a specific asset or commodity at a predetermined price and date. The assets covered by futures contracts can include stocks, bonds, commodities, currencies, interest rates, and more.

Futures are often traded speculatively, with the owner of the contract selling at a higher rate than they bought, or buying back a contract they sold at a lower rate, without ever intending to take delivery of the underlying asset.

Futures are popular because they allow investors to use leverage to magnify their returns. However, this also means that losses can be magnified, making futures a risky investment strategy.

Understand the basics of futures trading

Futures trading is the act of buying and selling futures. A futures contract is a financial instrument through which a buyer and seller agree to transact an asset at a fixed price at a future date. The buyer is obligated to buy, and the seller is obligated to sell.

Futures contracts are derivatives, which are financial contracts whose value comes from changes in the price of the underlying asset. They are traded on futures exchanges, such as the Chicago Mercantile Exchange.

Futures contracts can be used to speculate on the future price of an asset or to hedge against existing positions. For example, if you own shares in companies on the US Tech 100 and are concerned about their value dropping, you could short a US Tech 100 index future to offset a proportion of your share position losses.

Futures contracts can be based on a wide range of underlying assets, including:

• Commodities such as oil, wheat, corn, gold, and silver
• Currencies such as the euro and the British pound
• Energy such as crude oil, natural gas, gasoline, and heating oil
• Equities such as stocks and groups of stocks
• Interest rates such as Treasury bills, notes, and bonds
• Cryptocurrencies such as Bitcoin and Ethereum

When trading futures, you can go long (predicting the price of the underlying asset will increase) or go short (predicting the price will decrease).

Futures are often traded with leverage, which means that you only need to put down a small percentage of the contract's value (known as margin) to open a position. This allows for increased market exposure but also increases the potential for larger gains or losses.

It's important to note that futures contracts have expiration dates, and you will need to close your position before the expiry date arrives.

Before trading futures, it's crucial to understand the risks involved, including price sensitivity and margin trading.

Choose a futures trading platform

When choosing a futures trading platform, investors should do their research and select one that aligns with their trading strategy and financial situation. Here are some key considerations to keep in mind:

• Intuitiveness and ease of use: Choose a platform that is intuitive and easy to navigate. It should have a user-friendly interface that allows you to place orders, manage your positions, and access various tools and indicators easily.
• Multiple order types: Look for a platform that offers multiple order types, such as market orders, limit orders, stop orders, and trailing stops. This will help you execute different trading strategies and manage your risk effectively.
• Competitive fees and commissions: Compare the fees and commissions charged by different platforms. Look for platforms with competitive pricing structures, including low trading fees, reasonable account maintenance fees, and minimal deposit requirements.
• Advanced features (for experienced traders): If you are an experienced trader, you may want a platform that provides advanced features such as algorithmic trading through application programming interface (API) access. This will allow you to automate your trading strategies and execute trades based on predefined rules and conditions.
• Mobile trading app: Consider choosing a platform that offers a mobile trading app. This will enable you to monitor your positions, place trades, and manage your account on the go, providing you with greater flexibility and convenience.
• Range of markets: Ensure that the platform provides access to a wide range of futures markets, including commodities, currencies, equities, interest rates, and more. This will give you the flexibility to diversify your portfolio and trade in the markets that align with your investment goals.
• Research and analytical tools: Look for a platform that offers a comprehensive suite of research and analytical tools, such as real-time market data, charts, indicators, and news. These tools will help you make more informed trading decisions and stay ahead of market trends.
• Customer support: Choose a platform that provides reliable customer support. Look for a platform with multiple support channels, such as live chat, email, and phone support, to ensure you can get timely assistance when needed.
• Security and regulation: Ensure that the platform is regulated by reputable financial authorities and has robust security measures in place to protect your personal information and funds.

By considering these factors, you can select a futures trading platform that suits your needs and provides you with the tools and resources necessary to successfully trade futures contracts.

Develop a trading plan

Developing a trading plan is essential for success in futures trading. Here are some key considerations for creating an effective trading plan:

• Entry and exit strategies: Decide on the criteria that will trigger your entry and exit into the market. This could be based on technical analysis, such as identifying specific price signals or indicators, or fundamental analysis, such as economic data or news events. For example, you may choose to enter a long position on a futures contract if a golden cross signal occurs, where the 50-day simple moving average crosses above the 200-day simple moving average.
• Risk management rules: Determine how much risk you are willing to take on each trade and set up appropriate risk management tools, such as stop-loss orders, to limit potential losses. For instance, you could place a stop-loss order 5% below your entry price to manage downside risk.
• Trading style: Decide whether you will be a short-term trader or a long-term investor. Short-term traders often work with front-month contracts, while long-term investors may look at longer-dated contracts.
• Trading strategy: Choose the trading strategy that aligns with your risk tolerance, investment goals, and market outlook. Common strategies include going long, going short, or using calendar spreads.
• Position sizing: Determine how much capital you are willing to commit to each trade and how you will manage your position size over time. Consider using position sizing techniques, such as fixed dollar amount or fixed ratio, to manage your risk effectively.
• Trading journal: Keep a detailed record of your trades, including entry and exit points, reasons for trades, and outcomes. This will help you identify patterns, refine your strategy, and improve your decision-making process.
• Market selection: Select the futures markets that align with your trading style and risk appetite. Consider factors such as volatility, liquidity, and your level of understanding of the underlying asset.
• Trading platform: Choose a trading platform that offers the tools and features you need to execute your trading plan effectively. Look for platforms that offer multiple order types, competitive fees, and access to the markets you want to trade.
• Money management: Determine how much capital you are willing to allocate to futures trading and how you will manage your overall risk exposure. Consider setting stop-loss orders or using other risk management techniques to protect your capital.

Pick a market

With various futures markets to choose from, you should establish which one is most suited to your individual trading style. Some markets experience higher volatility than others and are better suited to short-term day traders. Other markets, such as gold or silver commodity futures, are often preferred by traders with lower risk appetites and less volatile markets. Remember, there are futures and forwards on indices, bonds, interest rates, shares, forex and ETFs.

For example, if you are interested in stock futures investing, you can trade futures of individual companies and shares of ETFs.

Futures contracts also exist for bonds and even bitcoin. Some traders like trading futures because they can take a substantial position (the amount invested) while putting up a relatively small amount of cash.

If you are keen on international markets, you may want to consider bond and treasury futures.

• Equity indexes, such as the S&P 500 or Nasdaq 100
• Hard commodities like precious metals
• Soft commodities, including agricultural products like livestock or crops
• Energy, such as crude oil and natural gas
• Currencies, including pairs like EUR/USD or GBP/JPY
• Treasury securities like US government bonds and rates
• Crypto, including Bitcoin and Ether

Open an account and place your first trade

To start trading futures, you will need to open an account with a broker that supports the markets you want to trade. A futures broker will likely ask about your experience with investing, income and net worth. This is to determine the amount of risk the broker will allow you to take on, in terms of margin and positions.

Once you have opened an account, you can log in to your broker's trading platform. Before placing your first trade, you should understand how futures trading works, including the risks involved. You should also pick a futures market to trade, such as commodities, currencies or equities.

When you are ready to place your first trade, you will need to decide whether to go long or short, depending on whether you expect the price of the underlying asset to rise or fall. You will then need to select a market on the trading platform, choose the 'Futures' tab, and decide whether you want to buy or sell. Finally, you will need to choose your position size.

It is important to remember that trading futures involves risk and you could lose money. You should only trade with money that you can afford to lose.

Frequently asked questions