Beginners Guide to Trading Futures - Part 1 of 3
Saturday, July 28, 2018
Beginners Guide to Futures Trading – Part 1 of 3
Over the course of this three-part series, we aim to fill a void in information online about how an uninformed individual might approach the temptation to enter the exhilarating world of futures trading. During part 1 of 3 below, we will answer the following common questions:
- What are futures?
- What are the advantages of trading futures over other product types (e.g. stocks)?
- How do I find the best futures broker?
- Should I use a broker?
If you have any questions about any of the content, feel free to get in touch with us at firstname.lastname@example.org.
What are futures?
Futures are standardised contracts bought and sold by traders who interact via a centralised exchange such as the Chicago Mercantile Exchange, ICE, Eurex, Liffe Euronext, OMX and others globally. The contracts specify the underlying product e.g. oil. Let’s use WTI Light Sweet Crude Oil which is traded on the New York Mercantile Exchange (NYMEX – part of CME Group) as our example. The contract also specifies the quantity of the product being bought and sold each time a futures contract changes hands - 1,000 barrels of crude oil in this case.
A futures contract always carries a settlement date at which point the parties still holding the contracts will hand over the agreed underlying product and the consideration/value being paid for that product. For this reason, the majority of traders never hold a futures contract all the way to settlement because while some futures are settled for their cash value others including oil are settled with a cash exchange for the physical delivery of the product. So, in this case to be specific, 1,000 barrels of oil will be available for collection “at any pipeline or storage facility in Cushing, Oklahoma” but the “delivery” of the oil must be completed during the specified delivery month. For oil, there is a delivery every month of the year and the following codes are used to distinguish the delivery months in question.
|Delivery Month||Code||Delivery Month||Code|
Other things specified in the contract specs of a futures contract is the minimum price fluctuation that the product trades in. Oil trades in increments of $0.01. This simply means that you buy at $69.00 per contract and can sell at $69.01 for example. Some products trade in increments that have four decimal places. This increment is important because futures are very highly leveraged products. For each 1 tick ($0.01) price increase/decrease in oil, the amount gained/lost on 1 contract (also called 1 lot) is $10. The full list of contract specs for each product should be viewed on the site of the exchange where the contract is traded. For Crude Light (CL), the CME website is the point of reference.
Why futures over other product types (e.g. stocks)?
As mentioned above, futures are highly leveraged products. With each $0.01 change in price worth $10 to your P&L, the rewards for being right in a trade can be very handsome. Be aware that there is a risk trade-off to this leverage also.
Futures markets are very liquid, meaning that there are huge volumes of orders in the market at every price meaning that entry and exit are much easier with futures than is often the case with stock and other product types.
Traders have direct market access to the exchange and can see very high levels of market depth. This means that traders are interfacing directly with each other rather than buying and selling to and from a broker middleman. Brokers are not involved in the actual interaction of trading except insofar as they guarantee that sufficient capital is in your account to cover the trade being undertaken. This direct interaction with other traders and ability to see their orders in the order book mean that futures trading is very transparent and manipulations such as insider trading are very difficult to undertake.
Importantly traders can take a short position which means that they can sell without having purchased the contract. If you do your analysis and feel like the price of oil will drop, you can sell immediately, without having ever bought oil. In theory, what you are doing is promising that if someone is willing to give you $69,000 on delivery, you will be happy to provide them with 1,000 barrels of oils but in practice, you are just momentarily speculating that the price will drop and that because you have the benefit of liquidity you will easily buy back the contract soon afterwards.
How do I find the best futures broker?
Barrons.com carries out an extensive annual review of the best online futures brokers ranked across several categories and is a good place to begin your search. Interactive Brokers regularly come out on top of the list for low cost and conditions that suit frequent as opposed to passive traders.
Given that this post is aimed at beginners it is fair to say that cost and minimum account deposit required should be of concern. I would suggest that you use Interactive Brokers as the benchmark and try to better the research carried out by Barron’s. Some other well-regarded futures brokers that work on a deep-discount model that are not reviewed by Barron’s are:
- AMP Futures
- Optimus Futures
- Stage 5 Trading
|Stage 5 Trading||$1,000|
You should also check the commissions charged per trade. Some brokers list their commissions for every time you enter a trade and exit a trade, usually termed “per side” and some list their commissions “per round turn” meaning the figure given considers the price of both entry into and exit from a trade.
Should I use a broker?
There’s a hint of bias here. The obvious answer from our perspective is no – don’t use a broker, come trade for TraderDock where you will first, practice your trading with logical, well-designed guidelines and then trade our capital rather than your own so you avoid personal downside risk. Alternatively, apply to a proprietary trading firm like our partners Positive Equity, who will draft you into their training program with a view to having you trade their capital for a profit share.
But let’s weigh up the alternatives to TraderDock. If you are coming out of college and feel like trading is for you, the main downside of trading futures is the level of capital you need to deposit to a trading account and the associated risk you are exposed to. This is not a child’s game. As all futures brokers state in their disclaimers, you can lose more than you deposit and you will be chased for extra funds should they fail to stop your trade out before you exceed your initial deposit. Typically, the minimum account balance for an online futures brokerage ranges from $5,000 to $10,000. For the brokerages mentioned above the required opening account balance are as follows:
|Broker Comparison||Minimum Deposit Required to Open Account|
(Subscription: $200 per month)
1.Graduate from Challenge
2. Trade Account worth $50k+
The TraderDock approach is to take a successful trading floor environment and replicate it with remote traders. We will soon be starting a trader chatroom dedicated to sharing ideas, mentoring and giving tips on what to look out for in the markets every week so that we can help traders get over the line and start trading real money. We have new dashboard features being added week on week to help you analyse your past performance and prepare for the next trading session.
Part 2 in this series will discuss the following:
- What hardware setup do I need to begin trading?
- What software should I choose?
- Should I use a squawk for news or any other news sources?
- How do I place my first trade?
- Trading Journal Template for Beginners