How to Trade Futures (Beginner's Guide)

Futures are standardized contracts that obligate the buyer to purchase, and the seller to sell, an asset at a predetermined price and date in the future. These contracts are typically traded on exchanges and can cover a wide range of underlying assets, including commodities like oil and gold, as well as financial instruments such as stock indices or currencies. Futures contracts are used by traders and investors for speculation, hedging, and more.

Futures contracts involve an agreement to buy or sell an asset at a predetermined price on a specified future date. Rather than owning the asset, you're locking in a price for a future transaction, betting on the direction you believe the price will move. Since there is no underlying product that you can hold forever like an equity, futures contracts are categorized as derivatives as each contract expires. Each contract typically has a different price too, as there are different perceived future prices of the product you’re trading. This is known as the forward curve.

When you enter a futures position, you’re required to put up a small deposit, known as margin, which allows you to control a much larger position than the actual value of the contract. This leverage can amplify your potential gains, but it also increases risk—if the market moves against your position, you could lose more than your initial margin. To close a position, you must enter an opposite trade—if you bought a contract, you’ll sell it, and if you sold a contract, you’ll buy it. This effectively locks in your profit or loss based on how the market has moved in relation to the price at which you entered the trade.

Futures contracts can be settled in two ways: physical delivery, where the actual asset is delivered to the buyer, or cash settlement, which is more common. With cash settlement, the difference between the contract price and the current market price is paid in cash, without any physical transfer of the asset. Futures trading offers flexibility, but also demands a thorough understanding of market movements and risk management. The timing of when the contract expires, the margin requirements, and the liquidity of the market will all impact your approach to trading futures. 

Let’s say you're an investor looking to protect your capital during a time of market uncertainty. Based on your analysis, you believe that gold is a good asset to hold as a safe haven, expecting its value to rise in response to broader economic volatility. You decide to use futures as a way to gain exposure to gold’s price movement without having to physically buy the asset.

The market assumption here is that gold’s price will increase over the next few months. To capitalize on this potential price increase, you plan to buy a gold futures contract, which allows you to speculate on the future price of gold without taking full ownership of it. With your market assumption in place, you’re ready to move forward by taking the necessary steps to enter and manage this futures position effectively.

For beginners, the world of futures trading can seem complex, but starting with a few simple strategies can help ease you into the market. The beauty of futures lies in their flexibility—whether you're speculating on price movements or using them for hedging, there are several basic strategies that can be effective without overwhelming a new trader. While there are more advanced strategies, getting comfortable with the basics is the key to building a solid foundation.

Here are a few simple futures strategies that beginners can consider, focusing on the fundamental concepts of buying, selling, and shorting futures contracts.

The most straightforward strategy is going long, or buying a futures contract. This involves purchasing a contract with the expectation that the price of the underlying asset will rise over time. For example, if you believe that the price of crude oil will increase, you might buy an oil futures contract. If the price of oil rises, you can sell the contract at a profit. This strategy is ideal for beginners because it’s based on the assumption that markets will follow the expected direction, making it relatively easy to understand.

Another fundamental strategy is going short, or selling futures. This is the opposite of going long—it involves selling a futures contract with the expectation that the price of the asset will decline. For example, if you believe that the price of a stock index, like the S&P 500, will fall, you might short a futures contract on that index. If the market moves downward, you can buy the contract back at a lower price, pocketing the difference as profit. While this strategy can be risky as there is no cap to how high a market price can go, it may be useful for hedging purposes—especially against a traditional equities portfolio with bullish positions. 

Hedging involves using futures contracts to offset potential losses in an existing position (or portfolio), offering a way to protect against adverse price movements. This strategy is also used by farmers that want to lock in a price for their crop. For example, if a corn farmer sees a spike in the price of corn futures that sets a multi-year high, they might short a contract close to their estimated crop yield to ensure that if the price drops, they’ve got a corn futures hedge that allows them to capture that price. This strategy is often used by more experienced traders, but can be helpful for beginners who want to protect existing investments. 

Trend-following is a strategy where traders look to ride the momentum of an asset's price movement. In futures trading, this might involve buying futures contracts during an upward price trend, or shorting during a downtrend. By following the prevailing market trend, traders aim to profit from sustained price movements. While not as straightforward as going long or short, trend following can be effective in markets that exhibit clear directional momentum. For beginners, combining this strategy with technical indicators, like moving averages, can help reveal trends with attractive entry points. Still, these indicators can reverse, so trade size is important to account for trends flipping quickly.

Futures contracts are available on a wide variety of products across multiple asset classes at tastytrade. These products range from commodities like oil and gold to financial instruments such as stock indices, currencies, and even interest rates. The diversity of futures products allows traders to speculate on many different types of markets and hedge against risks in various sectors. Whether you're interested in physical commodities or more abstract financial instruments, there's a futures contract for almost every situation.

Here are some of the main types of futures products available for trading:

Futures trading offers several potential advantages, especially for those looking to speculate on price movements or hedge against risks in various markets. One of the main benefits is the ability to use leverage. With futures, traders only need to put up a small margin relative to the total contract value, allowing them to control a larger position than they would be able to with the same amount of capital. This leverage amplifies the potential for higher returns on a smaller initial investment. However, it’s important to remember that leverage also increases the risk, as losses can exceed the initial margin if the market moves against your position.

Another key advantage of futures trading is the ability to hedge against price fluctuations in other investments. Futures contracts can be used to offset potential losses in underlying assets, offering a way to manage risk in sectors such as commodities, stocks, or currencies. For instance, if you hold physical assets like oil or agricultural products, you can use futures to lock in prices and protect your portfolio from adverse price movements. 

Furthermore, the diversity of products available in the futures market allows traders to engage in many different asset classes, providing ample opportunities for diversification and strategic positioning based on market conditions. With the ability to trade 24/5 and to access both long and short positions, futures trading offers flexibility, efficiency, and the potential for both risk management and profit generation across a wide spectrum of market environments.

While futures trading offers significant potential for profit, it also comes with its share of risks. One of the primary risks is leverage, which can amplify both gains and losses. Futures contracts allow traders to control large positions with a relatively small initial margin, meaning that even a small price movement can have a large impact on the trader's account. While this can lead to substantial profits if the market moves in your favor, it can also result in significant losses if the market moves against you. This makes risk management, including setting stop-loss orders, essential when trading futures.

Another key risk in futures trading is market volatility, particularly for commodities and currencies, which can experience sudden, unpredictable price swings. Economic events, geopolitical instability, or market sentiment can trigger sharp price changes, making it challenging to predict short-term movements accurately. Futures contracts have expiration dates, which means positions must be closed or rolled over by a certain time, adding another layer of complexity. 

Additionally, liquidity risk can occur, especially in less-traded markets, where it may be harder to enter or exit a position at the desired price. If market participants are scarce, abrupt price gaps may occur—potentially accompanied by wide bid-ask spreads—making it more difficult to execute trades efficiently. Overall, while futures provide opportunities for profit, they also require careful planning, effective risk management, and a strong understanding of market dynamics to navigate these positions successfully.

The futures market attracts a diverse range of participants, each with distinct objectives and strategies. Hedgers, such as businesses and producers, are among the most common participants. They use futures to protect themselves from the risks of price fluctuations in the commodities they produce or use. For example, a farmer might use futures to lock in the price of wheat before harvest, safeguarding against potential price drops. Similarly, airlines might use fuel futures to hedge against rising fuel costs.

Speculators are another significant group in the futures market. These participants aim to profit from price movements in the underlying asset without any intention of taking physical delivery. Speculators play a key role in providing liquidity to the market, and they can range from individual traders to large institutional investors. They may go long or short on futures contracts, looking to capitalize on price increases or decreases, often using leverage to maximize their returns.

Brokers and market makers play an essential role by facilitating trades and ensuring liquidity, enabling buyers and sellers to execute their orders efficiently. Together, all of these market participants help create a dynamic, liquid marketplace where a wide range of market needs are met.

• Futures contracts are agreements to buy or sell an asset at a predetermined price on a specific future date, allowing traders to speculate or hedge against price fluctuations.

• The leverage offered in futures trading allows traders to control large positions with relatively small amounts of capital, amplifying both potential gains and losses.

• Liquidity plays a crucial role in futures trading. Higher liquidity can help ensure tighter spreads and easier entry/exit from positions.

• Hedging with futures is a common strategy used by businesses and investors to protect against price risks in commodities, currencies, and other markets.

• Speculators in futures seek to profit from price movements in the market, thus contributing to market liquidity and efficiency. 

• Short selling in futures allows traders to profit from price declines by selling contracts with the intention of buying them back at a lower price.

• Futures markets are highly volatile, and price movements can be swift, so effective risk management—such as using stop-loss orders—can be essential for protecting against adverse market moves.

• Futures trading provides access to a wide range of asset classes, including commodities, stock indices, currencies, and interest rates, offering a wide range of diversification choices. 

• Margin requirements are set for futures trades, requiring only a fraction of the contract’s value upfront, but market participants must monitor their margin closely to avoid margin calls during volatile market conditions.