While futures trading is no doubt used for speculation over a matter of months, it can also be put to use as a tool in much shorter-term transactions, allowing traders to capitalise on the advantages of futures without having to put in the time and effort associated with predicting longer term positions or tying up their capital for lengthy periods of time.

In fact, there are a variety of trading strategies deployed by futures traders that are specifically designed for short-term applications, chasing more frequent, shallower profits to compensate from the larger gains that can be felt over longer time periods.

Futures Day Trading

Trading futures on a day trading basis is not uncommon, and in fact as an instrument futures are often more suited to trading commodities and certain types of asset class on an ultra short-term basis than many of their more traditional counterparts.

Day trading, in a nutshell, is the process of trading over the course of and within the hours of a single trading day, although the strategy isn’t so rigid as to totally prevent traders from rolling overnight if they so wish. In effect, day trading is just trading on a particularly short-term basis, with a view to making a larger number of smaller gains.

Within the realms of day trading are a number of more specific strategies that traders can implement, allowing them to use futures in a way that maximises their natural advantages as an instrument – for example, the leverage futures contracts afford. Here are but a few of the more common short term trading strategies you can implement, either as part of a wider day trading approach or for a short-to-short-medium term trading run.

Going Long

‘Going long’ is the process of backing a futures contract on an asset that will rise in price over the period of the investment. Generally, this is forecast on the basis of technical analysis, or information relating to the asset and the wider market, which can allow prices to flourish. For example, a company might release stronger results than the market had anticipated, or adverse weather conditions might affect the harvest of soft commodities – both of which will drive up the prices of the respective futures contracts over time. The theory holds that by spotting the likely trend before the rest of the world, or at least by acting swiftly to take a long position as the market starts to rise, the trader can profit from the percentage increase in price over the short trading period thanks to the significant leverage afforded by trading on margin.

Going Short

The antithesis of going long, going short can also be employed as a short term trading tactic to help futures traders capitalise on negative market movements. An equally popular strategy, some traders rely more heavily on identifying underlying weaknesses in assets and instruments, in order to benefit when market pricing collapses. This can be a useful strategy to leverage market panic or anxiety in the wake of some market or industry disaster, and can be equally (if not more) profitable than going long given the risk adversity of many of the larger investment players.

Scalping

Combining both a long and short outlook into short term trading, scalping allows traders to bank small profits on numerous transactions as soon as they arise, theoretically reducing the risk of exposure to the market. Scalpers aim to move in and out of positions quickly to bank small profits while dodging the potential of wayward market movements. As a short term trading strategy, it can be particularly effective when implemented with futures contracts, which enable traders to cash in on the leverage effect while minimising the physical time period during which their investments can go awry.

Futures trading is applicable as both a short and long term trading tool, with each outlook having its own particular strengths, depending on experience levels and risk appetite. While there are a variety of nuanced strategies built around the idea of trading short-term, having a command of both the objectives and discipline of short-term trading will stand you in good stead to profit from the futures markets, whatever challenges they may present.

While trading futures for the long-term is naturally difficult, both as a result of a fixed expiry date and the costs involved in financing leveraged positions for lengthy periods, holding on to your futures can be a solid way of avoiding the short-term turmoil of the markets, and provided you have the patience and nerve to see your futures contracts through, the value in doing so can be significant.

Trading futures over the longer-term requires a strategic approach to identifying viable investments and deciding how to respond to given trading circumstances. Whether it’s picking and holding on the strength of economic data, or trading with the general trend of pricing, there are a number of strategies traders deploy when dealing in futures contracts with a longer-term outlook.

Macro-Trading

One of the key areas of interest for longer-term trading is what is known as macro trading. Macro refers to trading single instruments off the back of wider, more universal triggers – usually the economy and world affairs. Macro traders look at the bigger picture, to try to identify trends that are likely to develop over the longer investment term, and in doing so locate stocks, commodities and indices that are likely to respond in a particular way to those trends – either going long, short, or on the basis of a constant fluctuation in prices.

Part of macro trading relies on an understanding of foundational economics. Before you dash off to buy a copy of Adam Smith’s seminal writings on the subject, it’s important that you appreciate that economics on a very basic level is simple, common sense. If it’s harder for the UK to get access to oil as a result of supply shortages, oil prices will rise. If unemployment levels fall, retailers will see an increase in sales, because people have more money to spend. While economics can be extrapolated into a tremendously difficult subject area, knowing the fundamentals of how every economic indicator will impact underlying asset prices (through the process of making logical connections as above), is enough to see most macro-traders through their early stages as they become more familiar and more accomplished at trading futures contracts.

Buy and Hold

Of course, one option that’s always present with futures trading is the ability to buy and hold futures contracts until they are settled. With many traders concerning themselves with speculating on the price of the instrument alone, it can be easy to forget that futures contracts are more than just academic – they are tangible investment products that legally compel action on a set date. As a result, futures contracts often lose their value in the run up to their maturity, as the value of locking in the futures price diminishes.

However, one strategy that can be deployed effectively in futures trading is to buy and hold your positions until they mature, allowing traders the full scope of gains to be realised from the duration of their trade. While trading in this sense requires a firm grasp of the calculations necessary to factor in financing and commission costs, it is nevertheless possible as a means of eradicating the often split-second decision making demands that can result in recklessness. That’s not to say that you should remain rigidly fixed in the face of adversity, but as a blueprint for longer-term trading, starting off with the outlook that winning trades should be seen to their conclusion can be a highly effective strategy, allowing you to capitalise on the positive positions to their fullest extent.

Indeed, depending on the nature of your overarching trading style, you may be reluctant to adopt a particular approach in either direction if it contrasts with how you normally trade, and this can be a significant barrier to choosing the most rational trading approach for a given instrument. Both long and short-term trading strategies are uniquely advantageous in certain circumstances, and a calculus of how these different styles compare is worthwhile in determining which best suits your trading situation.

Short Term Advantages

When it comes to trading anything with leverage, short-term approaches are often easier to implement than long-term approaches, for several key reasons. While they may prove easier, it is also normally the case that short-term trading requires more work and engagement with your trading account, and any insulation from significant risk must be met with corresponding difficulties.

Firstly, short-term trading allows traders to hold up on their exposure to risk, simply because positions aren’t usually open long enough to encounter any serious damage. Of course, this simultaneously means individual transactions tend to be less profitable when they go well, but especially for new and inexperienced traders, the lower risk profile makes short-term trading seem much more worthwhile.

Likewise, with short-term futures trading strategies, you’re not so concerned with wider market and economic data – moreover, simply by understanding the immediate trend of asset prices, it is possible to profit by trading on a combination of technical analysis and common sense. If a share price is recovering from a slump, buy it. If oil prices are falling from a record high, sell it. With the benefits of leverage on your side, this can make short-term a trading a no-brainer, and is perhaps one of the most basic ways to start grinding out a return from futures trading.

Long Term Advantages

Long term trading, while perhaps more difficult to accurately predict, protects traders from market volatility and opens the door to much more profitable trades, and much less trader input. It stands to reason that a short-term trader gunning for smaller returns will be required to source a greater number of trades in order to make the same kind of money as they would on larger, more long-term trades. This means an increased research burden and more time spent at the trading desk, often for the same or less reward. For this reason, many professional traders soon switch away from short-term trading, with a view to executing more precise but much longer-term positions.

But the real biggie when it comes to advantages on the side of long-term futures trading is the transaction cost. Brokers almost always charge a commission on the size of each transaction, as part of their charging structure and revenue model.

Some traders fall for the fallacy that because this portion is often expressed as part of the overall profit or loss calculus that it barely matters – in effect, that the bottom line is all that counts. That couldn’t be further from the truth, and this form of disguising trading costs works a treat for many short-term traders. A crucial advantage with trading less frequently is that it is less expensive, in the sense that broker fees are reduced.

While on an incremental basis this might seem like a negligible cost, these charges can quickly mount up over time, especially with ultra short term trading strategies, effectively handicapping the trader and his chances of success. Long term trading allows you to be more sparing in the positions you adopt, saving you both the research time and the transactional costs incurred on a per-trade investment.

Market Volatility

The first crucial contributing factor to any good short-term futures position is market volatility. Market volatility is the degree to which the market moves in either direction over a short space of time. A more volatile market will swing rapidly in either direction, gaining and losing substantial value in a shorter space of time than a less volatile market, which will by definition be more price-stable. The higher the market volatility, the more opportunity you have to profit from a short-term trade in that market.

Conversely, more stable markets will stay within a narrow price range, which will squeeze your margins and make it much more difficult to trade profitably. While this does limit the risk of exposure, short-term futures trading demands participation in more volatile markets in order to deliver the real revenue potential.

High/Low Pricing

Alongside the degree of volatility in a particular market, you must also consider recent high and low price points for both the futures contract at hand and the underlying markets. When it comes to trading anything, knowledge is power, and this is most certainly the case in trading on a short-term basis.

By knowing the numbers and how current trading and market reaction measures up against recent past performance, you can start to build a three-dimensional picture of what’s going on with the specific underlying asset at hand, which will better enable you to make decisions on which direction the market is likely to move. If a futures contract is trading at around its mid-point and could respond in either direction, it’s perhaps best to avoid jumping in. But if a future is trading at an all time record high and some market factor plays in to the equation with a negative, you know that the futures contract is heading south, and that it has far to fall.

Knowing this information is the difference between landing on short-term trades that are something special, versus grinding out miniscule profits from essentially lucky trades.

Price Triggers

Thirdly, looking out for price triggers completes the puzzle of identifying viable trading options. Price triggers are the factors that prompt the market to either buy or sell, thereby affecting the price of both the futures contract and the underlying asset. The futures market tends to lag behind the underlying market in how it responds to price triggers, so having this information at the ready to make instant decisions (in conjunction with other indicators and investment intelligence) can pay off big-time. Look out for the macro-economic price triggers that happen every day, and think about how they might play in to the fortunes of a particular industry. When you’re trading short-term, price triggers like these are an essential indicator of profit potential, and by unlocking how these triggers actually impact on futures price is critical to squeezing a profit.

Nevertheless, for the trader who learns how to master the art of identifying profitable long-term futures opportunities, the path to all the upsides of futures trading with less effort, cost and heartache than short-term trading should be more readily conquered.

Choosing a long-term investment opportunity, regardless of the instrument concerned, requires that the underlying asset, commodity or index is fundamentally strong or weak. Prices move almost every minute of the trading day, but value is a much more inherent, in-built concept.

While the market for mobile technologies might fall away on the day, you can rest assured that Vodafone is, generally speaking, a solid company. Similarly, while oil prices might slide on the day, you can pretty much bet the farm that they will, in the long-term, continue to rise in price as resources become more scarce and demand continues to rise. Both propositions would be inherently valuable, regardless of whether the market was having an off-day, and it is establishing this underlying value that is important in delineating those assets that are ripe for a long term, profitable investment, versus the steady Eddies who are unlikely to go anywhere fast.

But underlying value (or, indeed, weakness) does not necessarily spell success for a long-term position. Remember that you have a fixed expiry date by which the market better have moved in your chosen direction in order to profit, so there needs to be some other factor in place that is likely to mark out a particular asset as a good long-term investment.

You’re looking for a price trigger that is driven by supply and demand or special yet foreseeable performance factor, and is has to be something that’s likely to really make share prices move. If you were investing in Apple, for instance, you’d want to be familiar with their upcoming product developments and how they were likely to change the tech space – these factors produce massive movements as the markets adjust, and if Apple deliver another iPhone or iPad you can bet the markets are going to jump on board wholeheartedly.

It is these additional factors, alongside inherent value and asset stability that lead to sensible long-term investment opportunities. Good companies, or in-demand commodities will always hold their value, but it is important to remember that you’re looking to invest in a futures contract with serious long-term profit potential. Bear in mind that to cover the financing costs and trading commissions as well as making it worth your while, you need to be sure that you’re picking the most prolific investment opportunities you can find, and that takes time and energy in the research phase. However, by ensuring you choose a solid company with a logical, realistic chance of price improvement over the period of your investment, you can be better placed to trade long-term futures on a profitable basis.

Before starting to trade futures, a crucial preliminary step lies in choosing a broker – again, assumed knowledge, and while it is fairly clear that a broker is necessary for futures trading, it isn’t necessarily the case that picking any old broker will yield results. The best advice you can take as far as choosing a broker is concerned is to spend time trying out various different demo accounts and interfaces with different brokers.

This is usually free of charge, and allows you to sample the look, feel and functionality of different brokerage platforms in order to determine which is most suitable for your trading style. Simultaneously, this can also be an effective way to start applying your theoretical knowledge to real-life trading scenarios, and in doing so refine your trading strategies prior to launching on the markets for real.

A fundamental part of trading futures, or any derivative for that matter, is having an appropriately robust plan in place – a strategy that you can adhere to in order to guide your trading decisions. A trading plan is put together by a trader usually at the outset of a new futures trading strategy, and should be constantly subject to review depending on your performance and objectives. As you become more familiar with the markets and the different trading strategies and techniques, you should begin to get a feel for the types of things that might form the parameters of your trading plan.

By doing the theory work in coming up with a plan you can implement and follow, you can give yourself the optimum chance of succeeding over time, assuming your approach to risk and your trading strategy checks out.

Having a trading plan cannot in itself make you a good trader, but it can certainly make you better, and can make decision making much easier. Suppose you were down on the day and were pondering your next move. A trading plan can highly where you’re at in terms of returns, and what the objective strategy should be in that situation in order to preserve or maximise your trading capital. At these high-risk, turning-point moments, having a plan in place can be crucial to ensuring a positive overall trading outcome.

Taking A Horse To Water

It’s all well and good to trumpet the advantages of having a trading plan, and most experienced traders will have quickly learned the importance of strategy and maintaining an objective lens when viewing trading performance. An altogether different matter is ensuring you implement and follow your trading strategy to a sufficient degree to deliver results.

In theory, a trading plan should demonstrate, by reference to trading strategies and markets, the manner in which you will and should trade to yield an overall profit once losses have been taken into account. On paper, you should be confident with the plan you have in place, and the techniques and decisions you will be making to deliver a return on your futures trading.

When it comes to implementation, many traders go one of two ways. Most commonly, they disregard the plan altogether, and trade one transaction at a time in a lust for quick profits. Some traders swing in the polar opposite degree, following their trading plans to the letter, to a fault. While a degree of discretion should always be maintained for dealing with unforeseen market circumstances, you should by and large tend towards following your plan. This will breed a heightened degree of consistency into your trading, and will eliminate much of the discretion and on-the-spot decision making that can so often spell disaster for futures traders.

The trading plan is not an optional extra – it’s essential if you’re serious about generating a return on your investment capital from the futures markets. Like a business plan, a trading plan not only helps iron out theoretical issues around your trading strategy, but also enables you to keep a firm grasp on the bigger picture, removing much of the subjectivity and discretion from the mix.

Take time to prepare a plan with strategies and trading behaviours you can comfortably manage over time, and don’t be scared to review your plan as you become more experienced or your objectives change. Ultimately, you should remember to consistently reference your plan, and to stick to the trading rules and guidelines set down in the calm, away from the heat of the trade.

All too often, the default position for new futures traders is to maximise earnings. This is obviously an admirable goal, and one that all traders should ultimately strive towards, but it shouldn’t come at the expense of managing risks and absorbing losing trades. The defensive angle to trading futures, or anything else for that matter, is equally as important as the offensive angle, and ensuring you have the right strategies and precautions in place to protect your capital can help you negate these adverse effects.

So how can you manage the inevitability of losing trades, and what methods, strategies and tools are available for minimising the potential for losses from bad trading decisions?

Cut and Run

The first strategy you can deploy to great effect in managing your exposure to losing trades is to cut and run. Counter intuitively, there is no point in allowing a losing position time to recover. If a position you have taken shows to be moving against you, the sooner you make the decision to cut your losses, the better positioned you will be. In effect, simply taking a small, upfront loss rather than a colossus negative later down the line can actually be a good thing, ridding your portfolio of a wasting position and freeing up your remaining equity to deploy in alternative market positions. As you leave profits to run for as long as possible, cut your losses as quickly as possible – particularly in highly leveraged transactions like futures trades where the risks can be that much greater.

Set Stops

A method for reducing your downside liability during a trade is through the use of guaranteed stop losses. Stops are automatic trigger price points at which your broker will automatically execute your chosen instruction – this might be to sell if a price hits a certain low, for example. Stops effectively set floor and ceiling triggers to cap losses and take profits automatically, and can be particularly useful in preventing losses in riskier positions. That said they are not recommended for use on every trade, and stops do have their own disadvantages that can serve as a handicap to trading performance. Stops are best used in greater risk scenarios.

Trade With The Trend

As a general principal, trading with the trend of the markets is one of the best ways to limit your exposure to risk and the resultant inevitable losses. If indicators point one way and market trends point the next, it will almost always be better in the short term to follow the market. Unless you have deep pockets and are able to fund your position until momentum shifts in your favour, you are usually better advised to trade in line with the general market trend. Remember that the futures markets are traded in huge volumes, and there’s very little you can do personally to shape the trading outcome. As a result, your best chance of success lies in trading with, rather than against, the price-setting crowd.

Manage Your Capital

Whenever you’re trading any amount of capital, it’s always essential to have more capital in reserve to absorb losses and prevent overtrading. The management of capital is an integral part of a safe investment strategy, and you should never be staking transactions than in aggregate pose a critical threat to your portfolio in the event of a market crash. Manage your capital conservatively in defence, and trade your allocated trading capital with vigour to achieve the best blend and afford the highest degree of protection against damaging losses.

As a result, many traders think of the risk vs. reward profile of a particular transaction as a ratio of expected upside gains to the allocated maximum financial risk of a particular trade, which helps break down a proposition into basic, manageable numbers. This enables more coherent, consistent decision-making and helps identify the best trading opportunities you are presented with. So how is the risk to reward ratio determined, and how can you start calculating risk: reward in your trading?

The Formula and Examples

As we’ve briefly mentioned, the formula for calculating risk to reward is mathematical, and will produce definitive numerical results. It’s important to understand that this bears no relation to the chance of failure – the ratio only calculates the size of potential downsides in comparison to upsides. So, it might be the case that there is a low risk to reward ratio where the risk is much more probably an outcome than the reward, even though the reward portion may be comparatively larger. It’s important to realise that while the risk-reward ratio is a vital, indispensible tool, it doesn’t reflect the whole picture and shouldn’t replace your personal common-sense filter.

The formula for calculating the risk-reward ratio can be expressed as Anticipated Profits: Anticipated Losses. In practice, the risk-reward ratio is only useful if it is taken to a common denominator – in other words, you need to then divide AP by AL to calculate the numerator figure. Here are a couple of worked examples.

Example 1

Futures on Company X shares are trending upwards. You buy at £10 per futures contract and anticipate the value will rise to £15. At the same time, you set a stop loss at £5, as the floor level at which you are willing to risk your position. The risk to reward ratio is calculated as follows

Anticipated profits: anticipated losses
£15-£10:£10-£5
£5:£5
1:1 ratio

Example 2

Futures on soya are trading at £12, and you anticipate a rise to £20 over the lifetime of your trade. You set a maximum loss of £10 on your futures. The risk to reward ratio is calculated as below

Anticipated profits: anticipated losses
£20-£12:£12-£10
8:2
4:1 ratio

The Benefits

The benefits of calculating and using the risk to reward ratio, while not absolute, are many and varied. Firstly, using the ratio enables you to identify at a glance whether a trade is an efficient way to deploy your capital. If the ratio is greater elsewhere, indicating a greater reward to risk, you will know that it perhaps represents a more advisable choice for your capital. When capital is your only asset, as with futures trading, making the most of it is crucial towards ensuring you maximise your earnings potential, and this is one way of achieving this end. Similarly, the risk reward ratio highlights instantly whether a proposition is too risky – something that isn’t always apparent from studying the numbers in abstract.

Additionally, having a ratio worked out to a common factor (i.e. x:1) allows you to compare different trades and transactions ahead of time. While the numbers involved might not lend themselves particularly to easy comparisons, using the ratio makes comparing like for like easy – crucial in allowing you to trade to your fullest potential.

Why Set A Target?

One of the real benefits of trading futures is that they bring the capacity for unlimited earnings on the upside, and are usually traded on margin through highly leveraged transactions. As a result, it can understandably seem like you’re the wet blanket at the party when you think about targets and limiting your returns. But setting a target for your desired earnings level is an important part of commanding your trading destiny, and by knowing the minimum amount of target earnings from each trade you can start to build objectives in to your trade-by-trade decision-making.

There’s nothing that says you have exit once you’ve reached your profit target. In fact, you could even account for the cost of a guaranteed stop in your profit expectations, position that underneath your target earnings level and carry on risk free until the market reverses. But by setting up a target from the outside and having a particular figure to work towards, you make sure that every position you trade is at least pulling its weight proportionate to the rest of your capital. This will give you more control over your portfolio, while making it much easier to keep a running balance of winning and losing trades.

Calculating Your Profit Target

Once you’re set on the value of having earnings targets forming part of your trading plan and your daily market decisions, you need to then think about what your magic number will be. The best way to compute profit targets is as a percentage. This allows you to make comparisons between transactions of different sizes to determine how effectively each performed on an equal, unweighted basis. Establishing this percentage level per transaction depends on a number of variable related to your trading account and expectations, and you should be careful to price each of these in when calculating your take from every trade.

Initially, you should work out how much of a percentage return you want to make per year. Remember to factor in capital you will hold in reserve – you might only trade, say 20% of your capital at any one time, so you want to make sure your returns on the 20% give a satisfactory return over time on the full 100% of your allocated capital.

Once you’ve worked out an annual yield, say 100% for simplicity, you then reverse engineer your profit target to a per-transaction level. This will indicate the degree of gain you should be expecting from each transaction you make, and will give you the key data you need to plan and forecast your trading performance. You should also take some time to play around with these numbers – information like the effect of varying degrees of loss on one or more of your trades, for example, might be critical in ensuring you hit your ongoing earnings targets.

Setting a profit target before you stake your capital in a futures trade is a wise move as far as establishing your expectations is concerned. As a means of keeping your trading in check and ensuring you’re sticking to a broader, logical plan, establishing the minimum profit take percentage for each trade is an essential process in formulating your trading style and determining your overall trading success.