Futures Trading Guide

Futures are perhaps one of the oldest derivatives, with ties as far back as the ancient Roman commercial system. Today, futures trading is a dynamic, cut and thrust, hi-tech world where traders shift billions every single day on notional future price movements, without necessarily ever coming within a country mile of the underlying asset. With a myriad of advantages over straightforward share dealing, futures trading has a lot to offer – but how can you use futures trading to maximize the returns from the capital you employ?

Futures trading can be defined as the trade in standardized, exchange-traded contracts to buy (or sell) an underlying asset at some specified future date. In plain English, that means an agreement that the bearer will buy the asset on which the futures contract depends at a specified future date and a specified future price.

In practice, this is generally just a cash transaction, so there’s no need to find yourself warehouse space capable of storing tons of commodities any time soon. Thus the trick to successful futures trading is to pinpoint when medium to long-term price outlooks look favourable and pounce on futures contracts when they’re priced at a point that allows sufficient profit in the transaction.

Futures contracts always specify a time period, an underlying asset and a price point, making for somewhat more sophisticated profit calculations compared with other instruments.

Is it more sensible to go for a 6 month or 12 month future? Does today’s price represent good value in relation to your forecast market movements, and do you anticipate markets moving in your direction in sufficient time to make it profitable? Will you hold on to your futures contract till the bitter end, or is there a chance they could expire without value depending on the movements of the markets? The futures trader has to weigh up many and varied different considerations, all the while running the risk of considerable downside liability on the maturation of the futures contract.

More often than not, traders close out their positions before the futures contract expires as a result of the time decay that occurs with futures contracts as they grow nearer their expiry date, and in a bid to mitigate against losses of negative markets while bank profits as they arise.

All things being equal, a futures contract will lose value every single day towards its expiry date, because the simple right to buy the asset at yesterday’s prices will diminish in value (unless the trader correctly predicts the market, in which case the value will rise). It is therefore the speculation on futures contracts that leads to profitability – effectively, the derivative trading form of a derivative instrument.

While futures trading can seem quite complex to the untrained eye, it is actually fairly simple to understand in practice the theoretical underpinnings of the instrument. While they’re certainly not an instrument for the faint hearted, futures contracts, when traded correctly, can be an excellent (and highly lucrative) addition to your trading portfolio.