Futures trading is a dynamic and potentially lucrative financial market that traders can take advantage of by speculating on the future price movement of various assets. Although it can be complicated at first glance and does involve a high level of risk, futures trading does offer opportunities for traders to diversify their portfolios. In this article, we take a deep dive into trading futures, so you can learn more about this exciting market.

What are futures?

A futures contract is essentially a legal agreement between two parties to sell or buy a particular underlying asset at a predetermined price at a specific time in the future. They are derivative financial instruments that obligate the buyer to buy from the seller and the seller to sell to the buyer, regardless of the current market price of the asset at the contract’s expiration date.

Futures contracts are also standardised in order to facilitate trading on a futures exchange. Traders mainly use futures for hedging and speculation purposes.

Types of futures available

Currently, there are plenty of futures contracts available. Below are a few examples of futures contracts that traders can choose to use:

• Currency futures: These types of futures provide traders with exposure to changes in interest rates and exchange rates across different national currencies.
• Financial futures: These futures contracts trade in the future value of an index or security. For instance, the NASDAQ and S&P 500 indexes. There are also futures for debt products, such as Treasury bonds.
• Energy futures: These contracts provide traders with exposure to common fuels and energy products such as natural gas, crude oil, gasoline, ethanol and more.
• Metal futures: Metal futures provide exposure to the price of certain metals. These metals are usually used as raw materials for construction and manufacturing. These include gold, silver, copper, and more.
• Agricultural futures: These types of futures were the original futures contracts available on exchanges. Much as their name suggests, these include commodities related to agriculture such as grain, lumber, sugar, coffee, milk, and even livestock.

Uses for futures

Futures are typically used in one of two ways – these are hedging and speculation purposes.

Speculating with futures

Futures contracts are typically liquid, and they can be bought and sold up to the expiration date. This is an important feature for speculative traders and investors, as they do not own the underlying asset of the futures contract, nor do they want to. Instead, they usually buy or sell futures in order to express an opinion about and potentially take advantage of the price movements of a particular asset. Then, before expiration, they will sell or buy another offsetting futures contract position in order to eliminate any obligation to the physical asset.

Hedging with futures

Futures contracts can be purchased or sold with the trader’s intention of delivering or receiving the underlying asset. These traders will usually use futures contracts for hedging purposes. This is because this helps them manage the future price risk of a particular asset or commodity in their operations or financial portfolio. For example, an oil producer may use futures to lock in the price they will sell oil, and then deliver the oil to buyers once the future contract reaches its expiration date. This way, they know in advance the price someone will pay for the oil, and they know someone will be taking delivery of the commodity.

How to trade futures

Below, we explore the steps one needs to take in order to start trading futures

Educate yourself

Before jumping into the financial markets, traders need to first educate themselves about what futures are, the futures market, and how futures can be used. Fortunately, there are currently plenty of educational resources available, such as online courses, blogs, tutorials, articles, books, videos and more for people to make use of. All of these resources can help provide valuable insight to traders as they begin their trading journey.

Traders should also take the time to research different types of futures contracts and pick the one that aligns with their trading strategy and risk tolerance level.

Choose a brokerage firm

Traders also need to pick a reputable brokerage firm. This is because brokers offer traders access to financial instruments, as well as the financial market. Additionally, it is important to remember that not all brokers are made the same – each will differ in their services and products offered, their fees, commissions, customer support, trading platform, and more. This is why traders need to do their due diligence and research the brokerage firm thoroughly before committing to working with one. It is highly recommended that traders also ensure that the broker they pick is regulated by relevant authorities in addition to offering competitive margins and fees.

Open a trading account

Once a brokerage firm has been chosen, traders will then have to open a trading account with the broker. This will entail providing documentation the broker requires, such as proof of identity (a passport or a government-issued identity card), and proof of address (a utility bill). Traders may also have to provide their tax identification number (TIN) as well. Once an account is registered and opened, a trader will need to fund the account, which can be done either through wire transfer, check, or credit card (depending on the brokerage firm). Some brokers will even require an initial minimum deposit in order for traders to begin live trading.

Develop a trading strategy

As a trader begins trading, they should create a well-thought-out trading strategy that includes any entry and exit points, risk management rules, and potential profit targets. This way, traders are not going in blind and are more likely to be focused and disciplined when trading. Traders can also backtest their strategies using historical data to check their performance.

Manage risk

Before opening a position, traders should consider ways to manage their risk. This can be done by adding stops and limits to their trades. A stop order automatically closes a position if the price moves to an unfavourable level. A limit order will close a position automatically if it moves to a more favourable level.

Bottom line

Futures trading offers opportunities for people to diversify their portfolios. However, it requires careful planning, education, and discipline. By understanding the basics of futures trading, one can start trading futures with confidence. Of course, remember that succeeding in futures trading takes time and experience, so it is best to be patient and continuously refine your skills.