Investors can trade futures to speculate or hedge on the price direction of a security, commodity, or financial instrument. To do this, traders purchase a futures contract, which is a legal agreement to buy or sell an asset at a predetermined price at a specified time in the future.
Futures came about in the mid-19th century, allowing grain farmers to sell their wheat for forward delivery. Futures trading provides investors with a fast and cost-effective means of accessing global financial and commodity markets.
As its name suggests, a futures contract is a financial instrument through which a buyer and seller agree to transact an asset at a fixed price at a future date. Despite a futures contract providing the opportunity for the delivery of an asset, most don’t result in physical delivery but are rather used by investors to speculate on a security’s price or hedge risk in a portfolio.
Traders can speculate on a wide range of securities and commodities by trading futures. Key futures markets include stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forests, and livestock. Most futures contracts are traded through centralized exchanges like the Chicago Board of Trade and the Chicago Mercantile Exchange (CME). Many cryptocurrency brokers, such as Binance, offer perpetual futures—a contract without an expiry date—allowing traders not to worry about an expiry month.
Leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment. Futures are traded with leverage on margin, allowing investors to control larger positions with a small initial outlay. However, this can be a double-edged sword if the asset’s price moves in the unintended direction. Traders should be aware they can lose more than their initial margin when trading futures contracts.
Investors can trade futures on everything from stock indexes to orange juice, helping to provide a diversified portfolio across multiple asset classes.
Futures allow traders to take advantage of opportunities nearly around the clock. For example, a trader may wish to go to long futures contracts on the Nasdaq 100 Index if several mega-cap technology stocks report better than expected earnings after the market close.
Investors can use futures to protect unrealized profits or minimize potential losses. The wide selection of futures products available allows traders to take a cost-effective hedge against the broader market or specific sectors and individual commodities.
Leverage is a double-edged sword. On the one hand, it can be advantageous to amplify returns with less of a cash outlay. However, if markets turn against you, you will be responsible for the full amounts of the losses and be subject to margin calls. In other words, leverage will also amplify losses.
Most futures contracts have an expiry date that traders need to monitor. As the contract approaches its expiry, its price may rapidly lose value or even become worthless. To combat this, investors frequently roll forward their futures contract to a longer-dated one as the expiry date approaches.
Leverage
Wide array of asset classes
Easy to short the market
Extended trading hours
Over-Leverage
Must manage contract expiration
Failure to roll or close positions can lead to physical delivery
When selecting a futures trading platform, investors should ensure that it is intuitive to use, offers multiple order types to help with risk management, and has competitive fees and commissions.
More advanced traders may want a platform that provides application programming interface (API) access to allow algorithmic trading functionality. Active traders should select a futures platform with a mobile trading app that lets you execute trades and manage positions on the go.
Today, most full-service online brokerages and trading platforms have access to futures trading. You will need to request and be granted approval to begin trading these markets.
As with trading stocks or other financial assets, it’s important that investors develop a plan for trading futures that outlines entry and exit strategies as well as risk management rules. For example, if a trader uses technical analysis to locate entries, they may decide to open a long futures trade on a golden cross signal—when the 50-day simple moving average (SMA) crosses above the 200-day simple moving average. The trading plan could also include a stop-loss order placed 5% below the entry price to manage downside risk.
Alternatively, a futures trading plan centered around fundamental analysis might generate buy or sell signals based on crop or energy inventory reports. For instance, a trader may short an oil futures contract if weekly oil inventories grow at a faster pace than analysts had expected. Of course, some traders may incorporate both technical and fundamental analysis into their futures trading plan.
In general, there are three futures trading plans:
Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.
Before trading futures, investors need to know several key elements about futures contracts to help determine position size and manage risk. These include contract size, contract value, and tick size. We’ll use the popular E-mini S&P 500 futures contract offered by the CME as an example.
As its name suggests, contract size refers to the deliverable quality of the asset that underlies the futures contract. For example, the E-mini S&P 500 is $50 times the price of the S&P 500 index.
Investors calculate the contract value by simply multiplying the contract size by the current price. Let's say a trader holds one contract of the E-mini S&P 500, and the underlying index is trading at $4,800. This means the contract value equals $240,000 ($50 x $4,800).
Tick size refers to the minimum price change of a futures contract. In other words, the smallest amount that the price of a particular contract can fluctuate. For instance, the E-mini S&P 500 has a tick size equal to one-quarter of an index point. As one index point equals $50 in the E-mini, one tick is the equivalent of $12.50 ($50/4).
Futures contracts are listed on several different products comprising many different asset classes. Among the most popular include:
Let’s put it all together in a trading example using the E-mini S&P 500 futures. The S&P 500 index recently broke out to a new all-time high, and we’d like to fade the move, hoping to book profits on a retracement to the initial breakout area around $4,720. Our money management rules stipulate that we risk no more than 1% of our futures trading account on any one trade. Additionally, our broker requires a margin of $12,000.
Therefore, we decide to open a short position, trading one contract and managing risk by placing a stop-loss $25, or 100 ticks, above our entry price at $4,786. As we are risking $1,250 ($12.50 per tick x 100), we should have at least $125,000 in our futures trading account to meet the 1% risk per trade rule ($1,250 = 1% of $125,000). Ideally, we should have more in our account to cover the $12,000 margin requirement and guard against margin calls if the price of the S&P 500 moves against us.
We then place a take-profit order at the initial breakout area at $4,720—264 ticks, or $66, below our entry price. If the market moves in our favor and hits the order, we make a profit of $3,300 ($12.50 per tick x 264).
Conversely, we incur a $1,250 loss if we get stopped out. In any case, the future trade offers a favorable risk/reward ratio of 1:2.64 ($1,250 risk per contract versus $3,300 reward per contract).
Investors can trade futures on stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forestry, and livestock.
Advantages include leverage, diversification, trading after hours, and hedging. Disadvantages include over-leverage and managing expiry dates.
Traders should select a futures trading platform that is intuitive to use, offers multiple order types, and has competitive fees and commissions.
When developing a futures trading plan, traders should include entry and exit strategies and basic risk management rules.
Futures are derivative contracts that let you speculate on the future price of some asset or commodity, or to let you hedge against existing positions. Because they utilize leverage, futures can amplify your bets, making for larger returns – but also larger losses. Futures also have expiration dates, so you need to be careful to roll over or close out positions so not to be stuck with physical delivery of unwanted commodities. To start trading futures, you will need to find a brokerage that offers access to these markets and then get approval.
Commodity Futures Trading Commission. "History of the CFTC."
Commodity Futures Trading Commission. "Basics of Futures Trading."
The U.S. Endowment for Forestry and Communities. "Future Markets."
CME Group. "Markets."
Binance. "What Are Perpetual Futures and Quarterly Futures."
Commodity Futures Trading Commission. "Economic Purpose of Futures Markets and How They Work."
CMEGroup. "E-mini S&P 500 Futures and Options."
Financial Futures Trading
Futures and Commodities Trading
Financial Futures Trading
Strategy & Education
Stock Markets
Stock Trading Strategy & Education
By clicking “Accept All Cookies”, you agree to the storing of cookies on your device to enhance site navigation, analyze site usage, and assist in our marketing efforts.