Mastering Futures Trading: A Comprehensive Guide for Beginners

Many private investors in the market utilize long-term strategies and a minimal set of assets, typically focusing on a few stocks, bonds, and one or two foreign currencies. However, exchanges offer participants a much wider range of instruments. In particular, savvy use of derivatives traded on the Exchange’s futures market allows for substantial profits to be made even from short-term market fluctuations. Most retail investors refrain from trading in futures contracts simply because they consider them extremely complex and are unsure how to trade futures and options.

What futures trading is used for

A futures contract is a standardized exchange-traded derivative contract that obligates parties to buy/sell a certain asset at a fixed price in the future. Futures trading has several key features:

  • Price. The price of the underlying asset is fixed at the time the contract is entered into.
  • Margin collateral. At the time of contract execution, it is not necessary to have the full amount or quantity of assets in the account. It is sufficient to have margin collateral, which is usually several times less than the actual contract volume.
  • The futures price differs. The futures price differs from the spot price of the underlying asset. Moreover, the difference in these prices varies for contracts with different expiration dates.

This leads to several ways of using futures contracts.

Hedging

Hedging is a strategy used by investors to protect themselves against adverse changes in the price of the underlying asset. One way to hedge is by buying futures contracts. Let’s explain with an example:

  • An investor holds 1000 shares purchased according to a «buy and hold» strategy. Even in crisis conditions, they do not intend to sell these assets but want to hedge their portfolio against a decline in the stock price. To hedge, they need to sell 10 futures contracts on these shares on the Exchange. This involves entering into positions in two opposite directions, resulting in losses on one being offset by profits on the other. When the downward movement ends, the investor will close the futures position. The profit in the account will completely offset the losses. At the same time, the spot position will remain unchanged.

Another less obvious hedging scenario:

  • An investor is confident that the price of shares has reached its bottom today and now is the best time to buy. However, they do not have the full amount to pay for 1000 shares at the moment, but they are sure they will have it in two months. By that time, the price of the shares may significantly increase, making the purchase less profitable. To acquire the shares at the best price, they buy 10 futures contracts with expiration dates closest to the time when the funds become available. Even if they sell the contract before expiration, the accrued variation margin on the futures will fully offset the purchase of shares at a higher price.

Speculative Operations

Since the margin requirement for a futures contract is significantly less than the cost of the corresponding volume of the underlying asset, this opens up wide opportunities for speculative profit. One way to profit is through trading futures with leverage. 

Another way to profit is through short sales. Experienced investors who know how to trade futures short had an excellent opportunity to profit from falling prices.

Important note! The profit from futures operations does not coincide with the change in the prices of the underlying asset. This is because futures contracts pricing considers long-term risks in addition to the value of the underlying asset. However, this difference is small; it is greater for distant contracts than for near ones.

Arbitrage

Futures contracts offer opportunities for arbitrage:

  • on spreads between different types of shares (ordinary and preferred) of the same issuer;
  • on spreads between prices of futures with different expiration dates.

In the first case, the investor buys futures on one type of shares (e.g., ordinary) and sells a contract with the same expiration date on others. In the second case, they buy, for example, a near futures contract and sell a distant one. Arbitrage operations in the spot market are considered almost risk-free, but their profitability is low. With futures, the use of margin collateral significantly increases this indicator.

Thus, trading futures can be extremely profitable. Here, as in margin trading, the return that the investor receives is practically unlimited. Moreover, experienced market participants are aware of additional income opportunities. For example, by law, futures trading can be done within an Individual Investment Account (IIA), allowing for tax deductions.

Step-by-Step Guide on How to Trade Futures on the Exchange

Many beginners in financial markets, and even many experienced private investors, do not trade futures because they do not know how to start trading on the futures market. However, there is nothing complicated about it. To trade, you need to:

  1. Choose a broker. Since futures trading is conducted only on the exchange, it cannot be done without an intermediary, for example primus market, who provides access to the futures. The same criteria should be used when choosing a broker for the stock market. Additionally, make sure that all FORTS (Exchange’s futures market) instruments will be available. If the broker provides access to different futures markets, this should be considered an additional advantage.
  2. Open a brokerage account. A single account allows you to perform all available trading operations, including trading futures. If the broker does not offer such an option, you need to open separate accounts or sub-accounts for trading on the futures market.
  3. Deposit the planned amount into the account for futures trading. If the broker offers several trading platforms, choose the most suitable one. To evaluate the advantages of each terminal, you can try each of them on a demo account.
  4. Select contracts for trading. The choice of which futures to trade depends on several factors: investor preferences, goals and selected strategies, market activity, etc. For example, the decision on which futures contract is best to trade for hedging is made based on the portfolio structure. At the same time, for speculative operations, the most liquid contracts are preferable.
  5. Wait for a signal to enter the market and place an order. In practice, this step in futures trading is little different from executing trades on any other market, such as stocks or currencies. However, analysis tools (technical analysis is more commonly used for futures) and approaches to capital and risk management may differ. After executing the order, monitor the open position (if early liquidation is planned) or wait for the expiration with automatic settlement.

Important! Since variation margin is accrued/collected twice a day (during clearing sessions), and the amount of margin collateral for the contract is recalculated, it is still necessary to pay attention to the open futures position at least once a day. The investor should ensure that there are sufficient funds in the account for the margin collateral even after recalculation. This will help avoid a margin call situation and forced position closure.

In conclusion, futures trading offers investors a diverse array of opportunities for hedging, speculation, and arbitrage. While it may initially seem complex, understanding the basics of futures trading and following a step-by-step approach can empower individuals to capitalize on market fluctuations and potentially achieve significant profits. With proper risk management strategies and access to educational resources, traders can navigate the futures market with confidence. As the financial landscape continues to evolve, futures trading remains a dynamic and essential component of global markets, providing avenues for both seasoned professionals and aspiring traders to participate in and profit from market movements.

Vivek is a published author of Meidilight and a cofounder of Zestful Outreach Agency. He is passionate about helping webmaster to rank their keywords through good-quality website backlinks. In his spare time, he loves to swim and cycle. You can find him on Twitter and Linkedin.