How to Trade Futures

Futures trading involves purchasing and selling futures contracts – agreements to buy or sell an asset at a set price on a future date. Futures traders can utilize futures contracts to either hedge against price fluctuations or speculate on market movements by agreeing on a price in the present.

Hedgers, such as producers and consumers of commodities, can use futures in an attempt to fix prices, stabilize revenues or costs, mitigate the risk of price fluctuations, and add predictability to their businesses. For example, a farmer might sell wheat futures before harvest to secure a price, while a food manufacturer might purchase wheat futures to lock in raw material costs.

On the other hand, institutional investors or retail traders may use futures for speculation and attempt to profit from volatility and price trends. When trading futures, speculators can use leverage to manage positions with only a portion of the total contract value, which can increase both profits and losses.

Futures contracts are far more complex than investments in a company’s common stock. Here's an overview of some important futures trading concepts:

Contracts: Each futures contract outlines the amount and quality of the underlying asset, the delivery date, and the price. Standardizing these terms promotes uniformity and minimizes confusion between buyers and sellers.

Trading: Futures contracts are tradable on platforms such as the Chicago Mercantile Exchange (CME). Traders can opt for either a long position (committing to buy the asset in the future) or a short position (committing to sell the asset in the future). Trading occurs through brokerage accounts (see our picks for the best brokers), and prices fluctuate based on supply and demand dynamics and market expectations.

Settlement: Futures contracts can be settled through the delivery of assets or a cash settlement. In delivery, the physical product is handed over at the end of the agreement. However, in cash settlement, individuals receive a sum equal to the difference between the agreed price and the market value at expiration, without any actual transfer of goods taking place.

Margins: Traders must provide margin – a percentage of the contract value – as a deposit when entering into a futures contract. Margins may be adjusted regularly based on price changes, known as mark-to-market.

The futures market covers a variety of underlying assets. Here are some of the most common asset categories in the futures market:

Commodity futures

Agriculture: This category includes futures contracts for crops such as wheat, coffee, and sugar, as well as livestock like hogs and cattle.

Energy Commodities: Futures related to oil, natural gas, gasoline, and heating oil fall under this classification.

Metals: This category encompasses precious metals (gold, silver, platinum) and industrial metals (copper, aluminum).

Financial Futures

Stock Index Futures: These contracts are tied to stock market indexes such as the S&P 500, Dow Jones, and Nasdaq.

Currency Futures: Includes popular currencies such as the U.S. dollar, euro, yen, and pound sterling. Bitcoin and Ethereum, the world’s two most prominent cryptocurrencies, also have futures available to trade.

Interest Rate Futures: These contracts involve government bonds, like U.S. Treasury bonds and various interest rate instruments.

Futures trading presents a unique set of advantages and disadvantages. Check out some of the pros and cons of futures trading below:

Pros of trading futures

Liquidity. Futures markets, especially those dealing with popular commodities and financial instruments, have high liquidity levels. Liquidity allows traders to quickly enter and exit positions without suffering slippage or poor fills.

Margin. Futures trading offers traders the opportunity to control positions using an amount of capital known as margin. This leverage can lead to increased profits if the market moves in the trader’s favor.

Range of assets. Trading futures can open up a new range of assets that traders might not typically deal in, such as commodities or currencies. Because roughly 75% of a stock’s move is correlated to the overall market, stock-focused investors can gain much-needed diversification through futures markets.

Cons of trading futures

Illiquid futures markets increase volatility, which can make it challenging for brokers to execute trades at expected prices.

Leverage is risky. High levels of leverage can introduce catastrophic risk if a trade goes in the wrong direction.

Knowledge and experience are required. The intricacy and unpredictability of futures markets can present risks to inexperienced traders. Judgment errors can result in substantial losses.

Check out our step-by-step guide to getting started with futures trading:

1. Choose a reputable broker. Find a futures broker that offers the best pricing, investment options, features, and tools (check out our guide to the best futures trading platforms). Once you've chosen a broker, you'll need to open a funded brokerage account with margin and futures trading approval.
2. Get familiar with your broker's platform. Before jumping into the complicated business of futures trading, you'll want to make sure you are comfortable with your broker's trading software. I recommend starting with paper trading to try out the platform without risking your funds.
3. Fund your trading account. As I mentioned above, a margin account is required to trade futures with an online broker. Unlike a margin loan to buy stocks, futures margin is a deposit against potential losses.
4. Put together a trading plan. Even the best traders can lose money, but the key to long-term success lies in sticking to a trading plan. Customize your plan for your own objectives, risk parameters, and trading style. Note: Sound risk management principles are important aspects of any trader's strategy.
5. Start trading futures. Now, you should be ready to start trading futures! That said, be wary; futures trading is risky. Potential profits (and losses) are tied to the tremendous leverage in futures contracts. Leverage magnifies even the smallest movements of an index or underlying asset.

Futures markets are typically available for trading around the clock, six days a week, starting from Sunday evening to Friday afternoon. Nonetheless, trading hours may differ based on the type of asset being traded. Be sure to confirm each futures market’s hours of operation before trading.

Each trader’s futures trading strategy can differ significantly based on their objectives, experience, account size, and risk appetite. Below, you’ll learn more about some of the most common futures trading strategies:

Trend Following

Trend followers track prevailing market trends by purchasing during price uptrends and selling during downtrends. This approach relies on indicators like moving averages, moving average crossovers (such as a “Golden Cross”), and trendlines to determine when to enter and exit positions.

Day Trading

Day traders buy and sell futures contracts within the same trading day. To succeed in this approach, one needs a grasp of how the market operates, technical analysis skills, and the ability to make swift decisions.

Swing Trading

Unlike day traders, swing traders hold on to their futures positions for days to weeks, aiming to take advantage of medium-term price trends. This strategy often leverages fundamental analysis to spot and capitalize on market trends.

Position Trading

Those involved in position trading opt for longer-term commitments by holding onto futures contracts for weeks, months, or even years. This style relies heavily on analysis and research to identify market trends and potential price shifts.

Arbitrage

Arbitrage is a trading method that takes advantage of price differences between markets or exchanges. For example, if the price of Bitcoin is vastly different on one exchange from another, an arbitrage futures trader may purchase a futures contract in one market while selling a contract in another market to turn a profit from the variation in prices. This approach necessitates transactions and a substantial amount of capital. Also, arbitrage traders must take into account trading fees.

Reversion-to-the Mean

A reversion-to-the-mean trade is a trading approach centered on the concept that asset prices or other financial indicators typically gravitate back to their average or mean over a period. Traders employing this method seek out assets that have strayed considerably from their average and make trades with the expectation of a return to “normalcy.”

Contrarian

This tactic involves fading the crowd (taking the opposite side of a more popular bet) by purchasing futures contracts when the majority are selling or selling futures contracts when most traders are buying. Contrarian traders hold the belief that markets tend to overreact, and by adopting positions opposite to the crowd, they can profit when the market eventually corrects itself.