Futures Trading Guide

Richard Montana | October 21, 2022

What is Futures Trading?

Futures are financial contracts that typically trade on an exchange in which two parties – one buyer and one seller – agree to exchange an underlying market for a fixed price at a future date (expiration date). One party agrees to buy a given quantity of securities or a commodity, and take delivery on a certain date.

The buyer in the futures contract is known as to hold a long position or simply long. The seller in the futures contracts is said to be having short position or simply short. The exchange acts as mediator and facilitator between the parties. In the beginning both the parties are required by the exchange to put beforehand a nominal account as part of contract known as the margin.

Many different commodities, currencies, and indexes are traded in futures, offering traders a wide array of products. Since futures contracts can be bought and re-sold any time the market is open up until the fulfilment date, they are a popular product among day traders. Futures can be used to hedge against risk or speculate the prices.

As an example, the futures contract size for gold is 100 ounces. Thus, if you are buying two gold future contracts, you are in control of 200 ounces of gold. If the price of gold increased by $1 an ounce, your position will change by $200 ($1 x 200 ounces). Each futures contract and commodity have their own unique characteristics.

What are Futures Contracts?

Futures contracts are an agreement to buy or sell a specified asset at a certain date and price. The asset can be tangible commodities such as grain, beef, corn, crude oil and metals. They can also be stocks, indices, commodities and currency pairs.

Trading futures can be a way for producers and suppliers of various commodities to try and avoid market volatility whilst investors can speculate on the price movement of the commodity in order to try and make a profit.

Standardized contracts help to ensure the ongoing stability of the futures market whereas supply and demand determine the commodity prices.

Futures give the buyer the obligation to buy the underlying market, and the seller the obligation to sell at or before the contract’s expiry.

What is the Futures Market?

A futures market is a central financial exchange for trading futures where you can buy and sell futures contracts. The New York Mercantile Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago Climate Futures Exchange, the Kansas City Board of Trade and the Minneapolis Grain Exchange are amongst some of the more popular futures exchanges.

How does Futures Trading Work?

Futures trading works by speculating on the price of an underlying futures market. Traders will look to go long (buy) a futures contract if they believe the price will rise or short (sell) a futures contract if they believe the price will fall. The difference in price between the price at the start and expiry date of the futures contract is the profit or loss from the contract. For each futures trade, there is a winner and a loser.

Futures are traded in a different manner to the more traditional stocks and shares. Futures are trades in contracts. Each futures contract has a standard size which is set by the futures exchange that it is traded on.

As an example, the futures contract size for gold is 100 ounces. Thus, if you are buying one gold futures contract, you are in control of 100 ounces of gold. If the price of gold increased by $2 an ounce, your position will change by $200 ($2 x 100 ounces). Each futures contract and commodity have their own unique characteristics.

Why Trade Futures?

There are some advantages to trading futures, and that includes the ability to buy long and sell short when speculating on prices. You can trade futures on a wide range of markets including stock futures, index futures, commodity futures, forex futures, bond futures and more.

You can trade futures contacts with leveraged positions when speculating which means that you are able to control a larger position size than you would have been able to do without leverage. However, whilst leverage can amplify potential profits, it also increases the potential loss if the market turns against you. It is imperative that you have a clear understanding of leveraged trading and the significant risks involved before you start trading futures with leveraged positions.

Futures contracts can also be used by corporations, fund managers and investors to hedge against losses elsewhere. Some will look to offset their price risk by obtaining a futures contract on a futures exchange, hereby securing themselves of a pre-determined price for their product. They are using their futures contract to try and reduce the overall risk of their investment portfolio.

For example, if an investor owned shares in companies that are listed on the FTSE 100 and were concerned about their value falling, they could short a FTSE 100 index future in order to try and offset a proportion of the share position losses.

How to Trade Futures?

If you have taken the time to read through the above, you should hopefully have an understanding of the futures market and how to trade futures. Here is a summary of the key steps:

1. Decide if futures trading is for you

Trading futures online carries an element of risk and can take more time than other forms of investing. You will need to research futures, manage your futures contracts, follow market news and decide how to react. It is important to understand the learning process, dedication and risks that comes with trading futures online.

2. Educate yourself

Before trading futures, it is imperative that you learn as much as possible about investing and the futures market. Any mistake could prove to be costly. There is an abundance of free educational materials provided by many online brokers that can help you to improve your trading skills and knowledge.

The majority of online brokerages will also provide a free demo trading account so that you can practice trading futures online with virtual funds in order to familiarise yourself with how they work, the trading platforms and to practice your trading strategies until you feel confident enough to open a real trading account.

3. Choose a futures broker

In order to trade futures online, you will need a broker account and trading platform to execute your trade positions through to the futures market. When choosing a broker, there are a few important things to consider such as regulation, commission fees, platforms, tools, education, funding options and customer support.

4. Research futures

If you have made it this far then you may be ready to start trading futures online! The next step is to research the different assets to discover which futures you may have an interest in trading. Perhaps there is a particular industry, product or service that is already of interest to you. Many brokers will allow you to filter future contracts according to various criteria in order to narrow down your search if need be.

With various futures markets to choose from, you should try to establish which one is most-suited to your individual trading style. Some indices such as the Germany 30 for example, can experience higher volatility than others, and may be better suited to short-term day traders.

Other markets, such as gold or silver commodity futures are often preferred by traders who have lower risk appetites and enjoy markets with lower volatility.

Many traders will begin by analysing different companies and industries, studying publicly available information such as finances, earnings and reports from professional analysts. The best brokers should have this information conveniently displayed for you within their trading platform.

5. Have a futures trading plan

Some of the most important factors that can help determine the performance of your futures contracts can be the trading plan and discipline. It is very important to have a solid trading plan personalised to your own needs that includes the money management and trading strategy that you will use. Most experts and professional traders would try to not let negative emotions such as fear, anger and greed affect their trading strategy.

6. Buy and sell futures

Once you know what futures you would like to trade online, you can analyse them to help decide if and when you will buy and sell future contracts.

Going long means that you are speculating on the value of a future increasing, and going short means that you are speculating on its value decreasing.

If you think that the underlying price of a future will increase based on your own fundamental and technical analysis, then you may consider opening a long position. If instead, your analysis suggests that the underlying market price will fall, then you may want to open a short position.

Before you open your position, you should consider adding stops and limits to your trade. Stops and limits are ways in which you can manage your risk while trading futures.

A stop order will close your position automatically if the price moves to a less favourable level, while a limit order will close your position automatically if it moves to a more favourable one.

After you’ve placed your trade, you will need to monitor it to ensure that the markets are behaving in the way that you had anticipated. If they are not, then you might want to close your trade to minimise your losses. If they are, then you might want to close your trade after reaching your target price level. This will all depend on your own money management strategy and personal preferences. Most brokers will allow you to close a futures contract trade before the expiry date of the contract arrives.

Choosing a Futures Broker

There are various factors worth considering if you are looking for a broker to trade futures online with. In this section, we will cover what we consider to be some of the most important aspects that you can look out for when choosing a futures broker.

Regulation

We deem the brokers regulation to be of the upmost importance. The reason being, is that a regulated broker must follow strict rules and regulations put in place in order to protect investors. They can offer some forms of protection that an unregulated brokerage firm cannot. Many experts and professionals would only ever trade with a regulated broker and they can give clients peace of mind that the broker has their best interests in mind.

Instruments

Futures contracts are an agreement to buy or sell a specified asset at a certain date and price. The asset can be tangible commodities such as grain, beef, corn, crude oil and metals. They can also be stocks, indices, ETFs, commodities, currency pairs and cryptocurrencies. Thus, if you would like to trade future contracts on a particular asset class, you will need to check that it is an available option at the broker you are considering. If you want to trade CFDs, options or spread bet, you should see if this is possible through the broker you are considering.

Fees

When you trade future contracts with a broker, they are likely to charge a commission fee. It is important that you are aware of all fees involved before taking out any future contracts. Generally speaking, the lower a brokerage fees are, the more you can save on trading costs over the long term. Aside from the commission fee, there may be other fees which you need to be aware of such as accounting fees, inactivity fees and more. If you are looking to save as much as possible on your trading costs, you can take a look at our best discount brokers.

Platforms

In order for clients to be able to take out future contracts, the broker provides them with a futures trading platform. There are various desktop, web and mobile trading apps available, some free and some paid. Each platform will have a choose of trading tools, features and functionalities. If you are already familiar with a specific trading platform, you may wish to check that the broker has it. Alternatively, you can opt for a popular and user-friendly futures platform such as MetaTrader or cTrader. You will find that there are lots of MetaTrader brokers which can give you convenient market access for your manual and automated trading strategies. If you don’t have the time or skills to trade and want to copy trading signals, you should look for a social trading platform.

Leverage

The futures markets typically use high leverage. Leverage means that the trader does not need to put up 100% of the contract’s value amount when entering into a trade. Instead, the broker would require an initial margin amount, which consists of a fraction of the total contract value.

For example, if you had an account balance of $500 and leverage of 1:5, you would be able to take a position size of $2,500 ($500 x 5 = $2,500).

Whilst this does mean that you can control a position size larger than you would have been able to without leverage, it also means the risk is significantly greater. It is imperative that you have a clear understanding of leverage and how it works before trading with leveraged positions.

Education

The best futures brokers should have a selection of educational resources available to help beginners improve their trading knowledge and skills. This can range from trading guides, tutorial videos, webinars, eBooks, quizzes and more. If you would like to learn more about futures trading, then you should check the broker has the relevant educational materials. If you are new to trading and need as much guidance as possible, you might want to explore our best brokers for beginners.

Tools

Whilst future trading platforms will have a range of built-in trading tools, some brokers provide traders with additional tools to help assist them with their daily trading activities. This can include economic calendars and earning reports which help clients to keep up to date with the latest market news and can be implemented as part of a fundamental analysis. Other tools can include trading calculators, trading signals, market alerts and more.

Signup

Each futures broker will have its own minimum deposit policy so check that you can meet this requirement. You may also need to provide some personal information in order to pass the brokers KYC and AML procedures. During the sign-up process it is very important to make sure that you read all of the brokers terms and conditions, only proceeding if you understand and agree with them.

Funding

Different brokers can have different account deposit and withdrawal methods. Whilst most future brokers will allow you to fund your account via wire transfer and credit/debit card, others will accept online payment methods such as Neteller, PayPal and Skrill. You may wish to check to make sure that the broker has an account funding option that is convenient for your needs. It is also important to check any broker or third-party fees that will occur when making deposits and withdrawals.

Support

There are futures brokers all over the globe. Some may operate customer support in different time zones, via different methods and different languages. You may wish to check where the brokers’ offices are located and if they are easily reachable. Many brokers will offer online chat, telephone and email support. You can check they have a contact option that works for you.

Conclusion

Futures are a financial derivative in which one party agrees with another party to buy or sell an asset at a predetermined price at some point in the future. Both physical commodities and financial instruments like stocks and bonds are traded using futures contracts.

Trading Futures offer a variety of advantages for anyone looking to diversify their portfolio and capitalize on the ever-changing world economy. With futures, traders can access nearly round the clock trading opportunities, choose to increase their leverage, and access highly liquid futures markets.

Now that you have had a brief overview of what future contracts are, you may be considering opening an online trading account to trade futures online. To do so, you can simply choose a futures trading broker, follow the account opening process and you will be able to start trading futures online through one of their futures trading platforms.

However, it is important to understand the significant risks involved with trading futures, especially when using leveraged positions. Most experts would suggest trading on a demo account with virtual funds to begin with. This can be a useful way to familiarise yourself with how to trade futures and use trading platforms whilst allowing you to practice your trading strategies until you feel confident and produce consistent results. Most futures brokers provide unlimited demo accounts free of charge.

Take your time to research brokers and do your own due diligence, the above information is only for educational purposes and not advice. Please feel free to view our best futures brokers if you need some further inspiration before you get started.

About the Author

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Richard Montana
Richard has many years of experience in broker research, testing, analysis and reviews. He knows what to look for through years of trading himself with different brokers and listening to the feedback of others.

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