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Due to popular demand, we bring you Echelon 1’s ‘Futures Trading How To’. 

There’s been immense interest in the Futures Market as of late. With unlimited profit potential, no time decay, no Option Greeks, no PDT Rule, and all hours trading – a new wave of online traders are turning to the Futures Exchange as their principal market of choice 

We’ve been urged to write this guide for those new to Futures.  Expand your knowledge and have a little more confidence jumping into your first Futures trade.

Whether you’re a stock trader, you’ve dabbled in other markets, or you’re a complete trading novice – we take you through the ins and outs of Futures. What is a Futures Contract? How do Futures work? Plus all the things you need to know to kick off your Futures Trading career.

What is the Futures Market?

The Futures Market is essentially akin to an auction market. It’s an online exchange where Buyers and Sellers come together to exchange products for delivery at a future date.  

To get a better understanding of Futures Markets, we should take a step back and look at why the Futures Exchange was created. Originally, farmers and dealers needed a way to shield themselves from an often volatile market where the price of goods would regularly swing from one extreme to the other. By committing to the future exchange of their products, both parties would benefit from price certainty.

For example, a livestock feed company that relies on the purchase of corn, may enter into a corn futures contract to avoid any unexpected price increases in that commodity. By entering into the futures contract, the livestock feed company locks in the price of corn by agreeing to buy a certain amount, for a specified price to be delivered at a future date. 

On the flip side, a corn producer may look to sell a futures contract to ensure that it has a steady market for its product and to protect against any unexpected future price drops. In this scenario, both parties are using the Futures Market to limit their exposure to the risks of wild price changes in the corn commodity as it plays a central role in their business functions.  

Fast forward to today, and Futures Markets are more than simply the exchange of agricultural goods. Financial products and derivatives are also commonly traded. You don’t even need to be a company that actually wants to supply or take delivery of a commodity to invest in the Futures Market. Many Futures traders have zero intention of ever taking possession of any of the underlying products. Rather Futures traders will buy and sell speculative plays to profit from price changes in commodities.  

What is a Futures Contract?

A futures contract is an agreement that two parties will trade an underlying asset at an agreed-upon price and date. The underlying asset can be a security, commodity, or financial instrument. From crude oil, wheat, gold, silver, Euro’s, British Pounds, Treasury Bonds, and the S&P 500 Index.

Types of Futures you can trade; Trading Futures; Commodities

Unlike options, a futures contract obligates the parties to fulfill the terms of the contract. The buyer of a futures contract must buy and the seller must sell. Unless the holder’s position is closed before the settlement date. 

How Does Trading Futures Work?

Trading Futures provide a simple, easy to understand, linear payoff. Traders profit when price action moves in their direction and lose when price action moves against them. 

There are two main ways to trade futures: speculating and hedging.

  • Futures Speculating — Where a trader takes a punt on the direction of the underlying’s price movement. A trader can either buy a speculative position if they think the price of the underlying will go up. And sell/short a speculative position of the underlying price is expected to fall.
  • Futures Hedging — Where a trader enters into a futures contract to reduce the risk of price changes in their overall portfolio. For example, a wheat farmer can enter into a futures contract to sell their wheat at a favorable price. This will protect the farmer from future negative price movements of wheat.

Once a trader has entered into a futures trade, they can close their position by selling the identical contract they originally bought or buying the identical contract they originally sold.

What happens if you don’t want to take possession of the goods? When it comes time for settlement, futures contracts will typically be settled in cash unless the contract is designated for ‘physical delivery’.

Why To Start Trading Futures?

No Time Decay

If you’re familiar with Options Contracts, you will no doubt be well acquainted with Theta and the Option Greeks. Time can burn through premium and be a constant source of misery for many options traders. 

Trading Futures contracts, on the other hand, have the huge advantage of not being negatively affected by time decay. This makes the pricing of futures contracts intuitively easier to understand than options.

Time does not reduce the value of Futures contracts because they are not optional . Futures contracts must be executed on the delivery date and the stipulated price. So regardless of whether you enter the trade a day or a year before the delivery date, the passage of time is one less thing you have to worry about with Futures. 

Liquidity and Overnight Trading

Futures markets are some of the most robust and liquid markets with huge amounts of contracts traded each and every day. They are also open for business almost 24 hours a day. Many from Sunday evening through to Friday afternoon. 

The high liquidity gives rise to narrow bid and ask spreads which limits profits lossed from slippage.

This flexibility in trading hours is a huge boon for traders working a 9–5 job. As well as overseas traders struggling with time zone difference. This ideal mix of time flexibility and liquidity reassures traders that they are able to enter and exit positions quickly in response to breaking news events around the clock. 

How To Start Trading Futures? 

Open a Futures Trading Account – Open An Account With Tradovate

First things first, you need to open a futures trading account. 

Most retail day traders use an online trading platform to execute trades so be sure to have a reliable and quick internet connection. 

When choosing a reputable online broker, be mindful that there is no industry standard for commission and fees for Futures Markets, so do your due diligence and shop around. Other things to look for are data speed, quick fills and executions, charting tools, customer service and be sure to check that the broker is regulated by the National Futures Association (NFA) and the Commodities Futures Trading Commission (CFTC). 

Tradovate is our preferred futures trading platform. They offer flat price, commission-free trading, with no platform licensing fees, order routing fees, or mobile app fees. You can check them out here.

Spend Time In The Futures Market and Build A Strategy 

Trading futures commodities is a whole different ball game to trading other markets. You need to be across the board with what’s happening in the world in regards to news, weather, dollar value, interest rates, demand etc. depending on the asset you wish to trade.

And yet, no amount of reading or studying the news is going to compare to the learning you get from time spent in the market. 

Observe the market. Get a feel for a few different commodities and decide which underlying asset you want to focus on. Do you have an interest in livestock? Metals? Stock indices? Learn everything you can about the underlying asset. Familiarise yourself with the nuances of how they move and how they react to different catalysts. With practice, diligence, and planning, things like entry timing, position-sizing, stop placement, and profit-taking become second nature. 

If you’re apprehensive about jumping headfirst into Futures Markets (and you should be! futures move quickly and require high amounts of leverage, so one wild price swing in the wrong direction can be financially devastating) Tradovate also offers a simulated trading platform or ‘paper trading’. While paper trading won’t replicate the emotional or psychological aspect of investing with real funds, it can be a useful trading tool. For those completely fresh and just want to dip their toes into the Futures Market — paper trade. Familiarise yourself with the new trading platform, check your understanding of the Futures Market and how things like margin and leverage work, develop a trading strategy and build your confidence.  

Understanding A Futures Contract 

We break down the components of a futures contract below:

Underlying Asset: Futures contracts are financial derivative products. Therefore they take their value from the price of the underlying asset. Each contract listed on the exchange is grouped according to its asset class such as Financials, Agriculture, Metals, Stock Indices etc.  

Contract Size –  All Futures contracts have a standardized size. For example – gold is 100 oz, crude oil is 1,000 barrels, corn is 5,000 bushels and the E-mini S&P 500 futures contracts is always $50 x S&P Index price. The size of the contract is determined by the exchange it’s traded on.

Deliverable – How the trade will be settled? Each contract is either settled in a ‘cash settlement’ or by ‘physical delivery’. Physical deliveries these days are quite rare and your broker should alert you if you are approaching a delivery period. Nevertheless, if you have taken a trade for ‘physical delivery’ be sure to close out your position well before the end date to avoid the hassle of taking or canceling delivery. 

Contract Month or Delivery Month –  This is the month the contracts are due to be settled. Some commodities can be delivered in any month, while others can only be delivered in certain months. The Delivery Month will be stipulated in the contract. For example in the futures ticker symbol: ‘SILU21’, ‘SIL’ = Silver futures, ‘U’= September, ‘21’=2021. 

Each month has a designation as seen in the below image.

How to read Futures Symbol; Futures Month Codes

Contract Value – The contract’s notional value is calculated by multiplying the size of the contract with the current price of the underlying. As futures contracts are valued by the price of the underlying asset, there is no way to exactly know just how much you stand to gain or lose.

Tick Size – Price changes in contracts are measured in ticks. The smallest amount the price of a particular contract can fluctuate is one tick. 

Currency – The currency denomination of the futures contract. 

There are also a number of abbreviations you should be aware of. We list some below: 

LTD – Last Trading Day – The last day you can close out a futures position before delivery (both cash and physical delivery).

FND – First Notice Day – The first day that a trader can take physical delivery of the underlying asset. Most traders will close their position prior to FND because they dont want to physically own the commodities. 

Things to Keep in Mind When Trading Futures

Margin Requirements

There are margin requirements involved in trading futures – initial margin and maintenance margin.

Futures Margins; Maintenance Margin; Variation Margin; Initial Margin; Margin Call

Rather than paying an upfront premium, futures trading involves putting down an initial margin to open a futures position. The initial margin is established by the exchange and is normally a small percentage of the futures contract. Many new futures traders are often surprised that the initial margins for futures contracts can be well into the thousands of dollars. This can be a major limiting factor preventing traders from entering the Futures Market. If you’re looking to start small, consider trading the Micro E-minis. Micro e-mini Futures Contracts allow retail traders to speculate on the futures markets with a small contract size that costs much less and has a far lower initial margin than trading the larger stock index futures contracts.

Aside from the initial margin, the trader will also need to sustain a ‘maintenance marginin their trading account for the duration of the contract . The maintenance margin will be specified in the contract terms. 

From there the balance of the maintenance margin will be adjusted every day in a process calledmark-to-market’. This is where the value of the position is calculated and the profit or loss is transferred into the trader’s account at the end of the trading day. If the margin drops below the maintenance level, the trader will receive a margin call. The trader will then be required to top up margin funds or reduce or liquidate the position. The remaining payment and commissions are settled at the end of the contract.

Leverage & Risk 

As traders only need to put down an initial margin to open a futures position, many futures traders typically use a substantial amount of leverage. 

Traders can enter a futures position with 10 times as much leverage to capital. Utilizing leverage can be a powerful way to exponentially increase profits. However, using leverage comes with enormous risk. Highly leveraged futures positions with large contract sizes expose traders to huge potential losses for even fractional price movements. As the Futures Market move quickly, a good judgment call can net a futures trader a swift and substantial profit. But on the flip side, a small fractional price movement in the wrong direction can amount to huge magnified losses. These losses can come just as quickly.

While investing in the Futures Market can be vastly different from trading Stocks, Options & Crypto, one thing remains the same – consistent success comes down to risk and trade management. Your trading plan is everything. With that being said, the best way to build a meticulous trading plan is to spend time in the markets. Observe and learn. You might choose to leap in headfirst. Start small with Micro E-mini Futures. Or cautiously paper trade until you build enough confidence and experience futures trading. No matter how you get started, futures trading is a fulfilling way to build wealth. Along with many other benefits in comparison to other markets. You ever know, it just might become your trading vehicle of choice.

How Echelon 1 can help. 

If you’re new to trading and want to learn how to navigate the stock, options, futures, and crypto markets with confidence, come join the Echelon 1 community. Be part of a thriving network of traders, analysts, and investors. Learn the fundamentals, receive mentorship from seasoned professionals, and have access to real-time analysis and member-only plays, so you can capitalize on the biggest moves in the market.

Welcome to the Echelon 1 community and take the guesswork out of your trading.


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