Futures trading is one of the oldest and most popular forms of derivatives trading. Whether you want to hedge your portfolio, speculate on price movements, or diversify your trading strategies, understanding futures is essential. In this guide, we will break down everything you need to know to get started.
What is a Futures Contract?
A futures contract is a legal agreement to buy or sell a specific asset at a predetermined price on a specific date in the future. Unlike stocks where you own a piece of a company, futures are contracts that derive their value from an underlying asset.
The simple version: A futures contract is like making a deal today to buy or sell something at a fixed price on a future date. Both parties are obligated to fulfill the contract when it expires.
How Do Futures Contracts Work?
Every futures contract has several key components:
- Underlying asset: What the contract is based on (oil, gold, S&P 500, etc.)
- Contract size: The quantity of the underlying asset in one contract
- Expiration date: When the contract settles
- Tick size: The minimum price movement
- Tick value: How much money each tick is worth
Example: E-mini S&P 500 Futures
Let us look at one of the most popular futures contracts:
- Symbol: ES
- Contract size: $50 x S&P 500 Index
- Tick size: 0.25 index points
- Tick value: $12.50 per tick
If the S&P 500 moves from 5000 to 5010, that is 40 ticks (10 points / 0.25). Each tick is worth $12.50, so the contract moved $500 (40 x $12.50).
Long vs Short Positions
In futures trading, you can profit whether prices go up or down:
Going Long (Buying)
When you go long, you are buying a futures contract. You profit when the price goes up. This is similar to buying a stock - you want to buy low and sell high.
Going Short (Selling)
When you go short, you are selling a futures contract. You profit when the price goes down. Unlike stocks, you do not need to borrow anything to short futures - you simply sell the contract first and buy it back later.
Long Trade Example
You think oil prices will rise.
- Buy 1 crude oil futures contract at $75.00
- Price rises to $77.00
- Sell the contract at $77.00
- Profit: $2.00 x 1,000 barrels = $2,000
Short Trade Example
You think oil prices will fall.
- Sell 1 crude oil futures contract at $75.00
- Price drops to $73.00
- Buy back the contract at $73.00
- Profit: $2.00 x 1,000 barrels = $2,000
Why Trade Futures?
Futures offer several advantages over other trading instruments:
- Leverage: Control large positions with relatively small capital (margin)
- Liquidity: Major futures markets are extremely liquid with tight spreads
- Extended hours: Trade nearly 24 hours a day, 5 days a week
- No pattern day trader rule: Unlike stocks, there is no $25,000 minimum for day trading
- Tax advantages: Futures have favorable 60/40 tax treatment in the US
- Easy short selling: No uptick rule or borrowing requirements
Types of Futures Markets
Futures are available on many different asset classes:
Stock Index Futures
Trade the broad market through index futures like the S&P 500 (ES), Nasdaq 100 (NQ), and Dow Jones (YM).
Commodity Futures
Trade physical goods like crude oil, gold, silver, natural gas, corn, soybeans, and wheat.
Currency Futures
Trade foreign exchange pairs like the Euro, British Pound, Japanese Yen, and Australian Dollar.
Interest Rate Futures
Trade bonds and interest rates through Treasury futures and Eurodollar contracts.
Understanding Margin in Futures
Futures trading uses margin, which is the amount of money required to open and hold a position. There are two types of margin:
- Initial margin: The amount required to open a new position
- Maintenance margin: The minimum amount you must maintain in your account
If your account falls below maintenance margin, you will receive a margin call and must deposit more funds or close positions.
Risks of Futures Trading
Futures trading comes with significant risks:
- Leverage amplifies losses: The same leverage that magnifies profits also magnifies losses
- Unlimited risk: Unlike options, futures have theoretically unlimited loss potential
- Margin calls: You can lose more than your initial investment
- Volatility: Prices can move quickly, especially during news events
Getting Started with Futures
- Learn the basics: Understand how futures work before risking real money
- Choose a broker: Select a reputable futures broker with competitive commissions
- Paper trade first: Practice with simulated trading to develop your strategy
- Start small: Begin with micro contracts that have lower capital requirements
- Manage risk: Always use stop losses and never risk more than you can afford to lose
Track Your Futures Trades
Pro Trader Dashboard helps you track all your futures trades automatically. Analyze your performance, identify patterns, and improve your trading with detailed analytics.
Summary
Futures trading offers unique opportunities for speculation and hedging across many asset classes. The leverage, liquidity, and flexibility make futures attractive to active traders. However, the same leverage that creates opportunity also creates risk. Start by understanding the basics, practice with paper trading, and begin with small positions as you develop your skills.
Ready to learn more? Check out our guide on futures contract specifications or learn about margin requirements.