How to Trade Futures

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Investing in futures is a commitment to buy or sell an asset at an already determined price and date in the future. Also known as derivative contracts, futures investing is not for the faint of heart. 

Futures can include a wide array of assets, commodities like soybeans and coffee, cryptocurrencies like Bitcoin and stock market indices like the S&P 500. Futures are traded on an exchange known as the futures market and can bring huge profits and losses. A typical futures contract consists of one party (the buyer) agreeing to take delivery of the item on a predetermined date.

How to Invest in Futures

In spite of the high risk of trading futures, it’s relatively easy (even for a beginner) to do. As an individual, you do not need a broker’s license, although all purchases will have to go through one. If you’re interested in buying futures, here’s a quick step-by-step tutorial to help get you started.

Step 1: Open an Account with a Futures Exchange

If you’re interested in trading futures but are just getting started, the first thing you’ll need to do is open an account with a licensed broker. Online trading companies like E*Trade do allow customers to trade in futures with a margin-enabled brokerage account or an eligible IRA account. Account minimums for trading in futures include $1,500 for margin accounts and a minimum net liquidation value (NLV) of $25,000 for trading in an IRA.

Step 2: Educate Yourself on the Futures Market

While you’re waiting for your account to get set up (or if you have an account already), it’s a good idea to learn how futures trading works and what the risks and benefits are. On the upside, unlike in the stock market, the futures market is open 24 hours a day. As well, short-selling of futures consists of the same margin requirement for long and short positions. On the downside, futures trading is extremely risky. Who knows what the price will be in a week or a month?

Step 3: Choose the Type of Futures Contracts to Trade

Once your account is set up and you feel comfortable with moving forward, you’ll need to choose which type of futures contracts and markets you want to trade in. Because futures markets can be so distinct, it’s a good idea to focus on one or two types of contracts at first. The most common categories include:

• Stock indices like the Dow Jones and S&P 500
• Energy contracts including oil and natural gas
• Precious metals such as gold and silver
• Agriculture commodities like soybeans and corn
• Livestock such as cattle and hogs

Step 4: Decide Your Trading Strategy

Just like when deciding on the types of contracts you want to trade, your strategy should include no more than one or two types. As a beginner, you’ll want to make prudent investments. Different types of futures trading include:

• Going long
• Going short
• Calendar spreads

Step 5: Start Trading Futures

Now that you’ve set up your account, study up on futures trading, choose your areas of expertise and your strategy and start investing. As a beginner, make sure you monitor your futures account carefully. Limit orders and stop losses can help manage risk.

How Do You Choose Futures to Invest In?

Now that you're in the futures business, it might be helpful to get a few pointers from the pros. According to Charles Schwab, futures trading tips include:

1. Make sure you’ve got a plan: The futures market is no place for improvisation. Making sure you’ve got a strategy when it comes to futures trading means not only knowing exactly where you’re going to get in but when you need to get out. If you’re going to trade futures, you’ve got to have an exit plan.
2. Make sure your positions are protected: Don’t just come up with a selling price in your head. To ensure your positions are protected, trade with a stop-loss order. 
3. Make sure you stay focused: As a beginner, you’ll want to be sure you don’t spread yourself too thin by investing in too many categories. Focus on and become an expert in one market, maybe two. This is good advice for the seasoned trader, too.
4. Pace yourself: Your first foray into the futures market, while looking to make money, should mostly be a learning experience. It’s a bad idea and risky to trade in 5 or 10 contracts at a time while you’re still learning. Instead, focus on just one type of contract, then two. Take your time and make sure you do it right.
5. Be patient: Trading futures is big-picture stuff. Don’t catch yourself glued to your trading monitor, sweating it out over every up and downtick in the market. Keep a long-term attitude toward your trades and the market.

How You Can Diversify With Futures

If you find yourself smack dab in the middle of a bull market, you might get the idea you can do no wrong. You may be right, for a while. Caution is the better part of valor, however, and it’s a good idea not to put all your eggs in one basket but diversify instead. 

What is diversification? Diversification is an investment strategy that includes having several or even many types of investments in your investment portfolio. For your futures portfolio, because of the risks, diversification with futures contract is highly recommended. Here are five tips on how you can protect your investments by diversifying with futures.

Spreading Out the Risk

When you invest in mutual funds, your money is diversified in the market, lessening your chances for losses if any one sector should crash. In the futures market, you can create your own virtual mutual fund by spreading your investments around to a handful or more companies you trust. The odds of them all dropping at the same time is less likely.

Investing in Indices

Indices themselves are made up of a large number of companies. Hedging your investments can be as simple as investing in such already diversified indices as the Dow Jones or S&P 500.

Employ Dollar-Cost Averaging

Dollar-cost averaging means that you should add money to your investments on a regular basis. Such a strategy helps to smooth out market volatility. It’s a proven technique that investing the same amount of money over a long period of time reduces your investment risk.

Know When it’s Time to Cash Out

Sure, buying and holding your investments shows stability. In the futures market, however, it’s just as important to know when to take your winnings and go home. Don’t be greedy. If you’re up 30% in 3 months, it might be wise to sell your holdings and start all over again.

Watch Out for Commissions

Keeping your expenses in check can really pay off over time. All those commissions and fees don’t look like much on their own, but when you add them all together you might be surprised to find out how much money you're spending. See if you’re better off paying monthly or transactional fees. The idea here is not necessarily to be cheap but cost-efficient. 

Compare Top Futures Brokers

If you’re looking to invest in futures — even if you’re just getting started — the first thing you need to do is become knowledgeable on the subject. There’s no better place than Benzinga to learn how to trade futures and derivatives. Compare futures brokers below.

Start Trading Futures Contracts Today

Futures contract investing can be a highly profitable and rewarding form of investing. There are many different types of futures contracts that investors can choose from, such as commodities, indices or currencies. However, the amount of risk associated with this type of investment is significantly higher than more traditional forms of investing. Therefore, before entering into any futures contract, it is important to understand the underlying asset, the trading mechanics, and the associated risks. It is also important to understand the tax implications of investing in futures contracts, as this can have a significant impact on your returns.

Frequently Asked Questions