How to Trade Futures: Platforms, Strategies, and Pros and Cons

Futures can be used to speculate or hedge on an asset's price direction

TIMOTHY SMITH

Updated September 15, 2024

Reviewed by

SAMANTHA SILBERSTEIN

Fact checked by

VIKKI VELASQUEZ

Fact checked by Vikki VelasquezFull Bio

Vikki Velasquez is a researcher and writer. She has managed and directed community and nonprofit organizations. She has researched social and economic issues and edited educational materials for the Greater Richmond area.

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Futures aren't a new financial instrument. They started in the mid-19th century, helping grain farmers sell wheat for forward delivery.1 Since then, they've grown to include various securities and commodities.

Futures trading lets investors quickly and cheaply access global markets. They can speculate or hedge on a security's price by buying a futures contract. A futures contract is a legal agreement to buy or sell an asset at a set price at a future time.

But what are the pros and cons of trading futures? This article looks at the benefits and challenges of futures trading.

KEY TAKEAWAYS

Investors can trade futures to speculate or hedge on the price direction of a security, commodity, or financial instrument.
Key futures markets include stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forestry, and livestock.
Advantages of futures trading include access to leverage and hedging while disadvantages include overleveraging and challenges presented by expiry dates.
Choose a futures trading platform that is intuitive, offers multiple order types, and has competitive fees and commissions.
A basic futures trading plan should include entry and exit strategies as well as risk management rules.

The Basics of Futures Trading

A futures contract is a financial instrument where a buyer and seller agree to trade an asset at a fixed price at a future date. Most futures contracts don't lead to physical delivery but are used for speculation or hedging in a portfolio.2

Traders can bet on many things by trading futures. They can choose from stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forests, and livestock.34

Most futures contracts are traded on places like the Chicago Board of Trade and the Chicago Mercantile Exchange (CME). Many cryptocurrency brokers, such as Binance, offer perpetual futures. These contracts never expire, so traders don't have to worry about them ending.5

Futures trading means investors must settle their contracts. This is different from options trading. Options give traders the right but not the duty to settle their contracts.

Advantages and Disadvantages of Futures Trading

Like any strategy, futures trading has its ups and downs. Knowing these can help both new and experienced investors.

Advantages

Leverage: Leverage lets investors use borrowed money to increase their returns. Futures are traded with leverage on margin. This means investors can handle big positions with a small amount of money. But, it can also lead to big losses if the market moves wrong. Traders should remember they can lose more than their initial margin when trading futures.6
Diversification: Futures let investors trade in many areas, like stock indexes or orange juice. This helps make their portfolio more diverse across different types of assets.
After-Hours Trading: Futures let traders work almost any time. For example, a trader might want to buy futures on the Nasdaq 100 Index if big tech stocks do well after hours.
Hedging: Investors can use futures to protect their gains or limit losses. With many futures products available, traders can easily hedge against market risks or specific sectors and commodities.

Disadvantages

Complex: Trading futures can be tricky. It takes a lot of time and effort to succeed. You need to keep up with the market and current events.
Over-Leverage: Leverage can be good because it lets you make more money with less money. But, if the market goes down, you could lose a lot. You might even get a margin call.
Managing Expiry Dates: Futures contracts have an expiry date you must watch. As it gets closer, the contract's value can drop fast. To avoid this, traders often roll forward their contracts to longer ones.
Physical Delivery: If you don't close your positions, you might get the asset. Then, you'll have to pay the agreed price.

Pros

Leverage
Wide array of asset classes
Easy to short the market
Extended trading hours

Cons

Complex
Over-Leverage
Must manage contract expiration
Failure to roll or close positions can lead to physical delivery

Selecting a Futures Trading Platform

Choosing a futures trading platform is important. What should you look for? Here are a few key things:

Is intuitive to use
Offers multiple order types to help with risk management
Has competitive fees and commissions

Advanced traders might want a platform with API access for algorithmic trading. Active traders should look for a mobile trading app for on-the-go trading.

Most online brokerages offer futures trading. You'll need to get approval to start trading.

Developing a Futures Trading Plan

Creating a trading plan is crucial, just like for stocks. It should include entry and exit strategies and risk management rules.

Traders using technical analysis might look for a golden cross signal. This is when the 50-day simple moving average (SMA) goes above the 200-day SMA. The plan might also include a stop-loss order 5% below the entry price to limit losses.

Trading Strategies and Plans

When trading futures, it's crucial to have a solid plan. This plan can be based on fundamental analysis or technical analysis. For example, a trader might use crop reports to decide when to buy or sell oil futures. Some traders combine both methods for a more comprehensive approach.

There are three main types of futures trading plans:

Long: Buy futures and profit when the prices increase.
Short: Sell futures contracts and profit when the prices decrease.
Spread: Buy different futures contracts and profit from price differences. This can be within the same product or between related products like crude oil and gasoline.

Technical analysis helps traders by looking at past price movements and volumes. It aims to find trends that can guide trading decisions.

Contract Specifications

Before trading futures, knowing the contract details is essential. These include contract size, value, and tick size. We'll use the E-mini S&P 500 futures contract as an example, offered by the Chicago Mercantile Exchange (CME).

Contract Size: The contract size is the deliverable asset quality. For example, the E-mini S&P 500 is $50 times the S&P 500 index price.
Contract Value: The contract value is the contract size times the current price. For instance, one E-mini S&P 500 contract at $4,800 has a value of $240,000.
Tick Size:The tick size is the smallest price change. For the E-mini S&P 500, it's one-quarter of an index point. With one index point being $50, one tick is $12.50.

Futures Markets to Trade

Futures contracts cover many products across various asset classes. Some of the most popular include:

Equity indexes, such as the S&P 500 or Nasdaq 100
Hard commodities like precious metals
Soft commodities, including agricultural products like livestock or crops
Energy, such as crude oil and natural gas
Currencies, including pairs like EUR/USD or GBP/JPY
Treasury securities like U.S. government bonds and rates
Crypto, including Bitcoin and Ether

Steps on How to Trade Futures

To start trading futures, follow these key steps:

Understand how it works. Trading futures contracts is different from regular trading. You need to know how contracts work, your role as a buyer or seller, and when they expire.
Know the risks. Futures trading comes with unique risks. These include price sensitivity and using borrowed capital, which can increase your losses.
Pick your market. You can trade stock futures, commodities, currency, or interest rate futures. Bond and Treasury futures are also options for international markets.
Narrow down your investment strategy. Decide if you'll go long, short, or use calendar spreads for both.
Finally, choose your trading platform. Pick one that fits your needs and trading style.

Putting It All Together

Let's look at a trading example with the E-mini S&P 500 futures. The S&P 500 index hit a new all-time high. We want to fade the move, hoping to profit from a retracement to $4,720.

Our rules say we risk no more than 1% of our account on any trade. Our broker requires a margin of $12,000.

We decide to short one contract. We manage risk with a stop-loss $25 above our entry price of $4,786. We risk $1,250, so we need at least $125,000 in our account. More is better to cover the $12,000 margin and avoid margin calls.

We set a take-profit order at $4,720. If the market hits this, we profit $3,300.

But if we get stopped out, we lose $1,250. The trade has a good risk/reward ratio of 1:2.64.

TradingView.com.

What Assets Can Be Traded Using Futures?

Futures contracts let investors bet on future prices of various assets. You can trade stocks, bonds, and commodities like energy and metals. Even cryptocurrencies are included.

What Are the Key Advantages and Disadvantages of Trading Futures?

Before trading futures, understand the pros and cons. Knowing this can help you avoid losses. Learn more at this link.

Advantages include using leverage and trading around the clock. You can also hedge against market risks. These benefits make futures appealing.

However, futures trading can be complex. It may lead to overleveraging. Managing expiry dates and physical delivery risks is crucial.

What Should I Look Out for When Selecting a Futures Trading Platform?

Choose a trading platform that fits your strategy and finances. Look for ease of use and various order types. Also, check the fees to ensure they're fair.

What Are Some Basics to Include in a Futures Trading Plan?

Your trading plan should reflect your strategy. It could be technical or fundamental analysis. Decide on your approach and set entry and exit plans. Don't forget risk management.

The Bottom Line

Futures contracts are for speculating or hedging. They use leverage, which can lead to big gains or losses. Be aware of expiration dates and physical delivery risks.

To trade futures, find a brokerage that offers access. Then, get approval to start.

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How to Trade Futures: Platforms, Strategies, and Pros and Cons