Futures trading allows investors to speculate on or hedge against price movements across various assets for profit. However, it is not without risk from market volatility. Due to its complexity, futures trading is often used by more experienced investors to potentially make money on market fluctuations.
What is futures trading?
Futures trading is the buying and selling of contracts to buy or sell a particular commodity or stock index at a predetermined price at a future date.(1)
While farmers and consumers originally used futures contracts to sell and purchase crops at set prices throughout the year, futures trading has become an increasingly popular strategy for regular investors for hedging against market volatility, diversification and strategic trading.(2) Most contracts are closed before expiration, avoiding physical delivery of the product. Whether they take a profit or loss on the futures contract depends on market movements.
Trading futures is riskier than stock trading, making it critical to understand how futures trading works before you get started.
How to trade futures in 6 steps
When you know how to trade futures, your whole investment portfolio opens up to new opportunities. All it takes is just a few steps.
1. Understand the basics of futures
Before you can trade futures, you need to know how they work.
A futures contract is when you enter into a contract to purchase or sell a specific commodity or stock index at a fixed price on a future date.(1) Futures trading generally uses an exchange registered with the Commodity Futures Trading Commission (CFTC).(3)
When trading futures, it is important to assess these key areas:
- Contract size. The contract size refers to the number of futures in the transaction.
- Tick size and value. Consider the contract value by assessing the current price and looking for the tick size, which shows the minimum price change guaranteed by the contract.
- Leverage. Leverage is required when trading futures, meaning traders control larger contract values with a fraction of the capital required. This amplifies both gains and losses.(4)
- Margin requirements. The margin requirements dictate the minimum capital required to purchase a futures position.
- Expiration and settlement date. Expiration is the last day you can trade the contract, while settlement is when gains, losses or physical delivery obligations are finalized.
2. Select a futures trading strategy
Futures can be everything from gold to cryptocurrency to stocks and indexes. There are also energy and agricultural futures available. Consider which markets interest you and whether you have any particular knowledge or experience in a certain sector.
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Regardless of whether you choose a commodity or an index, these are some factors that can aid your decision.
- Market type. Several types of futures contracts incorporate markets like financial, metal, agricultural, energy and cryptocurrency. To create the best strategy, it helps to know how to trade in oil or whichever commodities you may be interested in.
- Contract specs. These specs outline the stipulations for trading specific futures.
- Liquidity. Liquidity shows how quickly you can sell or buy a futures contract with minimal impact on cost.(5)
- Volatility. Volatility in futures refers to how much securities are subject to change. The higher the volatility, the more the security is likely to change.
3. Open a futures trading account
To get started trading futures, you will first need a brokerage account or individual retirement account (IRA).
How to create an account will vary by platform. Here is an example using Robinhood’s mobile app.
- Download the Robinhood app and tap Sign Up.
- Provide your email address and legal name. Tap Continue to verify your identity.
- Enter and verify your phone number.
- Add your date of birth, home address and country of citizenship.
- Tap Continue to further verify your identity.
- Enter your Social Security number.
Next, you will need to answer some questions about your investment experience. If approved, you will receive an email. You will then need to review the terms and conditions and agree before you can proceed with funding your account and learning about how to trade futures on Robinhood’s app.
- $1.25 commission per futures contract
- Trade index, currency, interest rates and commodity futures
- Pro-grade platform with risk analysis tools
- $0.50 commission per futures contract with Gold
- Trade index, energy, currency, metals and crypto futures
- Customizable chart with advanced trading tools
- $0.89 per side for standard & e-mini contract
- $0.40 per side for micro contract commission
- Trade futures on crypto, energy, metal, equity, interest rates and more
- Trade without commissions with a bonus of up to $200 when you make your first deposit
4. Research the underlying asset
Take the time to research stocks, exchange-traded funds (ETFs) and indexes to see which might be the best for your portfolio.
- Consider your comfort level with risk and identify your overall trading objectives.
- Check volatility to see how much movement you can expect with a particular security.
- Look for key trends that can help you project future gains or losses.
- Review valuable insights on market projections from industry experts.
- Consider enlisting the help of a financial advisor if necessary.
5. Choose your futures and place the trade
When you are ready to begin trading, access your brokerage platform.
- Navigate to the futures trading section.
- Select your futures product.
- Opt whether to buy or sell.
- Enter the trade details, such as the order type, position size and price.
- Manage risk by placing stop-loss and take-profit orders if needed.
- Review your order and then submit it to place your trade.
6. Monitor the trade
Once you make your trade, it is critical that you monitor it to track movement. This way, you can act when the market changes.
- Adjust stop-loss or take-profit orders. These features allow for better risk management without constant oversight.
- Monitor margin levels. This is the amount of funds required for a futures position.
- Close the position before expiration (or hold for settlement). You can either sell before the expiration date or hold to settle your current position.
Review and refine your strategy
After closing the trade, take the time to review its performance. Consider how your investing strategy can be improved or adjusted to net better gains in the future. Working with a financial advisor can help you determine the best strategy for your portfolio.
Futures trading examples
There are three main futures trading strategies: long, short and spread.
When you buy long, you buy futures expecting an increase in price. You profit as prices increase from the purchase price but experience losses when it decreases.
Buying short is the exact opposite — you purchase futures with the expectation that the price will go down. You sell when prices decrease, earning a profit. However, losses occur when the price increases above the sale price.
A spread strategy allows you to buy different futures contracts and capitalize on the difference. You could purchase two different types of commodities, such as crude oil and gasoline, and go long on one position while going short on the other. You earn a profit on the ensuing difference.
Futures trading fees to consider
Futures contracts hold certain fees that can affect your profit.
- Commissions. This fee is paid out to the brokerage service handling your trade and can either be tiered or based on each contract.
- Contract fees. Additional contract fees, such as open and close fees, may apply and may be either tiered or fixed, depending on your trade.
- Exchange fees. These are assessed by the exchange where futures are being traded.
- Regulatory fees. The National Futures Association (NFA) charges a small fee to cover operational costs.(6)
Futures trading advantages and risks
There are both benefits and drawbacks of futures trading that are important to consider.
Advantages
- Leverage. With leverage, you can borrow money to increase potential gains, allowing you to use a smaller investment when trading on margin.
- Diversification. If you are looking to diversify your portfolio, futures allow you to invest in a wide variety of securities that include both traditional investments like stocks and physical goods like gold.
- Hedging. You can hedge both short and long positions, limiting your losses through locked-in prices and offset positions.
- After-hours trading. Futures are available long after the stock market closes, allowing nearly uninterrupted trading for investors.
Risks
- Complexity. Futures trading can be more complicated than other investments like stocks and bonds, requiring strategy and knowledge of the market.
- Over-leverage. Leverage can help you take advantage of positive growth, but you could also find yourself on the hook for serious losses if the market moves against your position.
- Managing expiry dates. Pay attention to the expiry date of your futures contract so you can track changes and act accordingly before the contract closes. You may be able to roll forward your futures contract into a new contract so you can maintain your position.
- Physical delivery. With some brokers like Interactive Brokers, you may be forced to take delivery of the underlying asset at the contract price if you do not close your position or roll forward your contract.
Bottom line
Futures trading can be a way to capitalize on market fluctuations, but it is important to understand the risks involved. When you are ready to get started, check out the best brokerage accounts available, and be sure to check if they allow futures trading on their platform — not all do.
Frequently asked questions
What is the 60/40 rule for trading futures?
The 60/40 rule is a tax provision under the US tax code applying to contracts for futures, options on futures and cash-settled index options.(7) It allows 60% of gains to be taxed as long-term gains and 40% as short-term gains.
How much money do I need to trade futures?
The exact amount of capital depends on the brokerage you use and the type of futures contract you enter into. For example, tastytrade does not have a minimum for account holders to trade futures in a margin account.
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