Do you want to know how to trade futures? Futures trading is popular due to the leverage and other benefits they provide.
I’ll be covering important futures trading basics which the first steps for learning how to trade futures.
After over three decades of trading professionally, I understand the importance of knowing the basics before pursuing ANY type of trading. Anytime you know what you’re doing, you automatically reduce your risk!
Keep reading, or grab my Futures Trading Made Simple eBook here.
Characteristics of Futures
A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price.
If you buy a futures contract, you are basically agreeing to buy something that a seller has not yet produced for a set price.
But participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering large inventories of physical commodities -- remember, buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than to exchange physical goods (which is the primary activity of the cash/spot market).
That is why futures are used as financial instruments by not only producers and consumers but also speculators.
The consensus in the investment world is that the futures market is a major financial hub, providing an outlet for intense competition among buyers and sellers and, more importantly, providing a center to manage price risks.
The futures market is extremely liquid, risky and complex by nature, but it can be understood if we break down how it functions.
In the futures market, margin has a definition distinct from its definition in the stock market, where margin is the use of borrowed money to purchase securities.
In the futures market, margin refers to the initial deposit of “good faith” made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any day-to-day losses.
When you open a futures contract, the futures exchange will state a minimum amount of money that you must deposit into your account. This original deposit of money is called the initial margin.
When your contract is liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the futures contract. In other words, the amount in your margin account changes daily as the market fluctuates in relation to your futures contract.
The minimum-level margin is determined by the futures exchange and is usually 5% to 10% of the futures contract. These predetermined initial margin amounts are continuously under review: at times of high market volatility, initial margin requirements can be raised.
The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished.
For example, if your margin account drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request that you make an additional deposit into your account to bring the margin back up to the initial amount.
How to Trade Futures -- The Markets
There are many quality futures markets around the world. Below are some but not all of the Futures markets that can be traded using the PCFDTM. I would recommend the main U.S. Equity Index markets to start with.
For active traders, the favorite and most popular futures markets, however, are the Equity index futures. While they all move in the same direction, there are differences in them that allow traders to match these markets to their personalities.
What Are Equity Index Futures?
Equity index futures are designed to trade in relation to a specific equity index which is comprised of a basket of securities. These products allow traders to speculate and hedge risk associated with these markets.
Benefits of Investing in Futures
The following is a unique combination of the benefits of investing in futures. These benefits offer individual investors traders and institutional traders many opportunities over other trading vehicles:
• Significant Tax Benefit
• Advantages of Stocks & Mutual funds combined
• Lower Margin costs
• Low Commissions
• Highly Liquid Investments
• Huge Volume
• Near 24-Hour Trading (except for a 15 minute period for settlement)
• Portfolio Diversification
• Lower risk than stocks (reduced overnight gap risk)
As you can see, the benefits of investing in futures are numerous. This is why futures trading is so popular with more advanced traders and financial institutions.
Where and How to Trade Futures
There are different places and ways to trade futures. The various trading vehicles and characteristics are outlined below.
• Very popular
• Highest volume / Most liquid
• $50.00 per point per contract (Example: If you buy 1 S&P E-mini Futures contract at 1365.00 and sell it at 1370.00, you made $250.00)
• Represents a basket of stocks (S&P 500)
• Very orderly market because of its high volume
• Ideal for the more conservative trader
• Solid volume
• $20.00 per point per contract
• Represents a basket of NASDAQ stocks
• Orderly market but larger swings partly because of lower volume than the S&P
• Low volume which means large swings in price, very volatile
• $5.00 per point per contract but don’t let that fool you, it is volatile
• Represents a basket of Dow stocks
• Because of low volume, you may consider doing your analysis for this market on the S&P chart
• Low volume
• Popular because of its price point, this is not a market for conservative personalities
• $100.00 per point per contract
• Represents a basket of Russell stocks
• The combination of low volume and the high price point means a big money, fast-moving market (not for the beginner)
• Similar to the Russell
• Lower volume
• Traded on the Eurex Exchange
• 25.00 Euros per full point, per contract
• This is a big money market that can really move so beginners beware
• Saving one of the best for last…
• Super high volume on a 100% electronic exchange (Eurex)
• 10.00 Euros per point, per contract
• For those in Europe, this is a great market to trade
In the world of equities, there are MANY different ways to take advantage of a move in the market. Knowing the details of the different markets helps you make the best decision based on your individual goals and requirements.
There’s a lot to understand with Futures Trading. Keep reading or Get my free Futures Trading Made Simple eBook here.
How to Trade Futures for the Individual Trader
My favorite vehicles for futures trading are the E-Mini S&P (ES) and also the NASDAX100 (NQ).
Advantages of Futures Trading with E-Mini’s
The E-Mini’s have many advantages outlined below.
1. Relatively Small Trade Size. The E-mini S&P (ES) Contract is 1/5th the size of the regular S&P Contract so a 1 point move in the market is equal to $50 per E Mini S&P contract instead of $250 per contract for the full-sized contract.
2. The E-mini NASDAQ 100 (NQ) ~ a 1 point move in the market is equal to $20 per E Mini NASDAQ 100. Each tick equals $5 per contract.
3. A Completely Electronic Market. There is no open outcry trading for the E Mini S&P (ES) or NQ contract, so all trades are made electronically, which many traders feel puts everyone on a more level playing field.
4. Highly Liquid Market. These contracts trade millions of contracts a day, meaning almost 24-hour liquidity and very low transaction costs.
If you want to continue to read more on Futures Trading, grab my free Futures Trading Made Simple eBook Below
Financial Benefits of Futures Trading
1. No Day-trading Restrictions. Unlike the stock market where you must have at least $25,000 in your account to day- trade, there are no such restrictions in the futures market.
2. Much Lower Margin Requirements. Day-trading margins for the E Mini S&P go as low as $500 per contract giving traders much more access to buying power than in the stock market. It is important to remember here however that leverage is a sword that cuts both ways, meaning that just as you can increase profit potential through the use of leverage this also increases your loss potential, something which we will cover in future lessons.
3. No Interest Paid on Margin. Unlike the stock market where you pay interest on margin used, you do not pay any interest on used margin in the futures market.
4. Tax Advantages. Futures Trades are generally taxed via the 60/40 rule meaning that 60% of gains are treated as long-term capital gains and 40% are treated as short-term capital gains.
For most short-term traders this tax treatment is a large advantage over the stock market, where 100% of short-term gains are taxed at the higher rate.
Now that I have covered the advantages of the trading futures, and the E Mini S&P 500 contract specifically, here are the general details about the contract which traders will want to know:
Trading Symbol: ES - The trading symbol for the E Mini S&P 500 contract is ES followed by the symbol for the month and year. For example, the June 2012 contract is ESM12.
Contract Size: $50 X the Index. For example, say the E Mini S&P 500 was 1365, which would make the contract size 1365 X $50 = $68,250.
Minimum Price Fluctuation: .25 Points or $12.50 equals 1 tick which is what the minimum price movement in a futures contract is referred to.
Trading Hours: Market is open from Sunday Night at 5 pm Central Standard Time, until Friday at 3:15 Central Standard time except for between 3:15-3:30 PM CST and 4:30 PM-5PM when the market is closed for maintenance.
Contract Months: H = March, M = June, U = September, Z = December
Last Day of Trading: 8:30 AM on the third Friday of the contract month.
As you can see, the benefits of futures trading are many. Before you can learn exactly how to trade futures, these important basics must be understood. As you can see, futures trading is a lot more complex than stock trading. Sometimes this can give an inside edge for individual traders willing to master this skill.