How to Trade Futures - Complete Futures Trading Guide
A futures contract is an agreement to buy or sell a particular market at a predetermined price at a certain time in the future. Traders can use them to speculate on the price direction of different assets such as forex, indices and commodities. Users can also trade futures CFDs which can make the futures market more accessible to beginner traders and those with small funds. Learn more about How to Trade Futures and the advantages and disadvantages of them.
Table of Contents
What are Futures Contracts
What are futures contracts? The first futures contract was written in 1851. The product was corn and it occurred at the Chicago Board of Trade (CBOT). The plan was for the seller (who was a farmer) and the buyer (an industrial company) to commit to a future exchange of products for cash at a fixed price.
Essentially, the seller of a futures contract would agree to sell a fixed quantity of a certain commodity on a particular day in the future to whoever wanted to buy the contract. The price of this contract would depend on the demand from buyers, as well as the supply from other sellers.
The futures market originated in the commodities industry. It was farmers, miners and oil producers who wanted to manage the risk of not knowing the price they would get for their product in the future. This gave birth to the futures contract. In a similar way, the buyer of the futures contract would agree on a fixed price to buy the underlying commodity from the seller on the expiration date of the contract.
Where are Futures Traded
You can now trade futures contracts on a wide range of markets including currencies, commodities and stock indices. The pricing of futures contracts depends on the supply and demand determined by the number of buyers and sellers. Futures are traded on on a futures exchange, such as:
- The Chicago Mercantile Exchange (CME)
- The Chicago Board of Trade (CBOT)
- The New York Mercantile Exchange (NYMEX)
- The InterContinental Exchange (ICE)
Futures exchanges can also be found across Europe and in other major financial trading hubs. The only difference now is that instead of people buying and selling contracts in the 'pit', it's all performed electronically through a broker.
How does Futures Trading Work?
So far we've mentioned who the futures market was designed for - businesses, farmers, miners and so on. However, because of the often extreme price movements in some of these markets, it has also given birth to speculators and different styles of futures trading.
One such style is day trading futures. In this type of trading, a trader would speculate on short term price movements throughout the trading day. Most day traders are highly active, often taking multiple positions a day to seek out a profit at the end. However, it is considered very risky to start out this way, especially for beginner traders.
Another style of trading is futures spread trading. The foundation of this style is to profit from the change in the price of two different positions. For example, a futures spread trader could take two positions at the same time, on the same market, but with different dates to try and profit from the price change. Some traders may elect to use longer-term strategies, but as you go on to learn about futures trading contract sizes, it really is for those with very large sums of capital.
Let's take a look at how trading futures contracts actually work.
How to Trade Futures Example
So far, we know that a futures contract is an agreement by one party to buy, or take delivery, of a product like a commodity or a currency, at a fixed future date and price. But how are they actually traded?
Futures are traded on exchanges where all contracts are standardised. This basically means that each contract has the same specification, no matter who is buying or selling. Contracts are typically standardised in terms of quality, quantity, and settlement dates. For example, everyone trading an oil contract on the New York Mercantile Exchange knows that one contract will consist of 1,000 barrels of the West Texas Intermediate (WTI) oil at a particular quality level.
Most futures contracts come in five-character codes. The first two characters identify the product, the third identifies the month, and the last two identify the year. For example, WTI oil could read CLX21. CL = Crude Oil, X = November (there is a certain code of months and letters listed on the relevant exchange's website) and 21 = the year 2021.
The first thing you will notice is that the name of the symbol is USTNote_U0. This means we are viewing the US Treasury Note in 'month U' of 2021. Looking at the Chicago Mercantile Exchange codes, the month U is in September. This means that this contract will expire in September. Here is a list of the futures trading codes for products traded via the Chicago Mercantile Exchange:
Of course, there are some disadvantages to having a fixed expiry date for your position (as we highlight further down in this article). Also, you cannot change the size of the contract, which can often be quite large. In the example of oil one contract is the equivalent to 1,000 barrels of oil. You cannot trade in less. As some futures contract sizes can be quite large, some of those involved in futures spread trading and day trading futures have turned to trading futures via CFDs.
Before we describe how you can trade futures CFDs, we will look at what you would need to get started with futures trading.
How to Develop a Futures Trading Strategy
When trading futures, it is not dissimilar from trading on any other market. Of course, there is a lot more to know about the expiry dates of your trades, as well as risk management and contract sizing. However, the process of developing a strategy is the same. Here are some key things to consider when getting started with futures trading strategies:
- What style of trading should I have? There are a variety of styles to choose from. Will you be day trading futures? Will you embark upon futures spread trading or futures options trading? Having a clear plan is essential in building a solid foundation from which to work from.
- What markets will I trade? Will you be trading on oil futures? Or perhaps commodity futures trading? Remember, each futures contract has different contract sizes and minimum amounts that you can trade. Traders with small accounts may struggle to find suitable markets to trade when trading futures.
- What strategy will I use? Your trading strategy helps to define your parameters for entering and exiting trades. Maybe you use trading indicators, or simple price action patterns to help you with your decisions. The key part is to try and remain consistent with your tools so that you can start to build a solid foundation upon which you will contribute toward your future success.
What are Futures CFDs
While futures trading can offer interesting opportunities, it can be quite daunting to retail traders as the contract size is often quite large. The possibility to trade futures via CFDs is more accessible. Let's look into why many traders opt to trade futures via CFDs.
A CFD, or contract for difference, is a derivative product that allows a trader to speculate on the rise and fall of a market. They were originally developed in the early 1990s in London by two investment bankers at UBS Warburg. Essentially, a CFD is a contract between two parties, the buyer and the seller. It stipulates that the seller will pay the buyer the difference between the current value of a market, and the value when the contract ends.
In this instance, the seller is usually your broker, unlike futures trading where you trade directly with an actual buyer or seller of the commodity you are trading. With a CFD, the trader pays the difference between the opening and closing price of the underlying market. Whilst CFD trading may seem similar to futures trading, there are some big differences.
Fortunately, you can start trading futures CFDs from a demo trading account. This allows you to trade in a virtual trading environment to sharpen your trading skills and build your trading strategy until you are ready to go live!
Differences Between CFD and Futures Trading
Expiry dates (monthly, quarterly)
Generally no expiry dates
Trade via an exchange (CBOT, CME, NYMEX)
Trade via a counterparty (your broker)
No ownership of product
No ownership of product
Can trade long and short
Can trade long and short
Tradable on margin
Tradeable on margin
Less markets available than CFDs
Can trade over 3,000+ markets
Advantages of Trading Futures
- Full Price Transparency: Futures are openly traded on public exchanges like the Chicago Mercantile Exchange. As they are frequently bought and sold by institutional investors and commercial companies, the pricing reflects the underlying market very closely. With CFDs, the price is calculated from the underlying futures market and then adjusted to accommodate the fees of the broker. These could be minimal or large in liquid markets, but higher in more exotic markets that are not traded as often.
- Cost-Effective for High-Level Traders: Commissions for futures contracts tend to be quite low in the larger markets. This makes it ideal for large quantity traders, due to the savings costs. However, as you will find out below, trading futures requires much more starting capital compared with CFDs.
Disadvantages of Trading Futures
- Big Contract Sizes: When trading futures you are buying a contract to buy a certain amount of a product or a commodity. These amounts are standardised. For example, Gold trades in a size of 100 ounces per contract, with every one-point move being an equivalent of $100. This means if you bought just one contract (the lowest you can buy on the futures market) then a ten-dollar move would mean that you would lose 1,000 USD. Gold is volatile and can move much more than ten dollars a day. With CFD trading you can adjust your contract size to fit in line with your own risk management.
- Expiration Dates: Every futures contract has an end date. This means the value of the contract is eroded the closer you get to the expiration date. It also means that if you wanted to stay in the trade for longer, it may not be possible to do so. With CFDs, there is no expiration date, which adds a great deal of flexibility for a trader who wants to exit their position when they want to.
- Fewer Markets Available: Whilst there is a good range of markets available for trading futures, it is nothing in comparison to the volume of markets available to trade with CFDs. For example, Admirals offers more than 3,000+ CFD instruments to trade on.
Trading futures contracts offer traders the ability to speculate on a wide range of currencies, commodities and stock indices. However, some of the contract sizing can be very large and may only be suitable for those with large trading accounts. As such, the margin requirements may also be very high. Some futures exchanges offer mini contracts, instead of standard sizes.
However, there are now many brokers that will futures CFD trading. This enables traders to speculate on the price direction of different markets at smaller contract sizes and - sometimes - with better margin requirements. By using a demo trading account, you can practice your skills in a virtual trading environment until you are ready to go live.
FAQs on Futures Trading
What is Futures Trading?
Futures trading is the speculation of the price direction of different asset classes in the futures market. Traders can buy or sell futures contracts that represent fixed quantities of currencies, commodities or stock indices. A futures contract is an agreement to buy or sell a financial instrument at a certain price and at a certain date. The aim of futures trading is to try and profit from the price swings that develop in the financial markets.
Can you trade futures in UK?
Futures trading is possible in the UK. Traders in the UK can open accounts with some US brokers that offer futures trading. Some UK brokers will also offer the trading of futures contracts. In most cases, UK traders can trade futures CFDs. A CFD is a derivative of the futures contracts and allows you to trade the contracts long or short using leverage.
Admirals is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or recommendation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.