So you want to trade futures in the hopes of speculating correctly and becoming wealthy in the process. The question you have to answer is: Are you prepared and ready to learn how this dynamic market works?
Futures do not trade in shares like stocks. They trade in contracts. Each futures contract has a standard size that is set by the futures exchange it trades on. For example, the contract size for gold futures is 100 ounces. That means when you are buying one contract of gold, you are really controlling 100 ounces of gold. If the price of gold moves $1 higher an ounce, that will affect the position by $100 ($1 x 100 ounces). You need to check each commodity or futures contract since each of them is unique.
How do you know if you are ready to trade futures? Ask yourself these questions to see if you believe you are ready.
- Trading futures contracts can be rewarding, as they are useful in leveraging speculative positions or hedging against losses elsewhere.
- Before diving in, however, it is important to understand how futures markets work and the key differences that exist in stock or bond markets.
- Leverage can amplify both profits and losses in futures positions, which may result in margin calls if the market turns against you.
- As with any market, sticking to a well-defined strategy and keeping your emotions in check is crucial.
How to Trade Futures Contracts
Win or Lose
Many people begin trading without fully understanding the fundamentals of the contract. Futures trading is a zero-sum game. For each trade, there is a winner and a loser. Many companies and professional fund managers use futures to hedge their other positions. They are using their futures contract to reduce the risk of their portfolio. This could be the jet fuel prices for an airline or gold produced by a mining company that wants to fix a specific sale price. While future contracts protect against the downside of price fluctuations, they also limit potential upsides as well.
When you trade futures for their own sake, it is like playing in a casino. The floor traders, futures exchanges, and a few experienced traders with deep pockets win in the long term. Most other traders end up losing their capital and leave poorer and disappointed.
Long-term success in futures trading comes from mastering three disciplines. If you are a successful stock trader, you are probably familiar with these rules. First, you need a proven trading process that works for futures trading. Next, proper money management techniques can go a long way to helping you win the futures trading game. Finally, any time your emotions control your trading, you are likely to lose.
Trying to master these techniques overnight while learning the futures game is foolish. You would be better off just giving your money to the experienced traders, as it would save on your emotional wear and tear. Before venturing into futures trading, be sure you are ready to take on those with more experience and success.
The Trading Process
Do you have a proven trading process that applies to futures trading? Keep in mind you are making bets on the trend in a futures contract where you compete with experienced pros who use their own trading process.
Ask yourself these questions to help you decide:
- Is your trading process focused on a long or short time frame? Futures contracts are available for many time frames creating opportunities that can be exploited.
- Do you use technical or fundamental analysis or both? Most professionals employ a blend of both methods, with one confirming the other.
- Do you have a special knowledge of a futures market that gives you an added advantage? For example, if you work in the energy industry you might know more than most about the important factors that determine the price of energy.
- Do you always use a well-defined trading plan that you follow without fail? Disciplined trading helps to level the playing field.
- Does your trading process recognize the market trend? Trading with the trend is a core strategy for futures traders.
- Does your trading process work well in up and down markets? Futures' trading does not depend on a bull or bear market. You can trade either way, depending on the trend in the futures instrument you are using.
A well-thought-out trading process gives you an edge. Be sure to use it.
Good money management is necessary for success in any trading situation. It is especially important in futures trading.
- Is your risk-reward method clearly articulated and implemented? For example, do you know in advance how much of your available capital you are willing to lose when trading futures? The corollary to this rule is being sure your process defines how much you can lose on each trade and that you enforce this rule.
- Each trader views risk from his or her own perspective. Are you aggressive or conservative? Either view works as a futures trader. Just be sure to sustain that view with each trade.
- Do you employ risk reduction techniques without fail? Proven techniques, such as position sizing and stop losses, are essential. Successful traders are willing to admit when they are wrong and get out of the trade.
Money management provides the tools to help you maximize your winning trades and minimize your losing ones. That is the secret to long-term profitable futures trading.
Lack of control over your emotions is one of the primary reasons traders fail. Fear, anxiety, and greed are common traits in everyone. Keeping them under control is an ongoing effort. When they take over, your trading results will suffer.
- How do you develop confidence in your trades? Do you use gut feel or good research? Confidence based on solid research helps to remove the emotion for the trading decision. Reading a blog or following someone else's lead without knowing why they are making the trade is a recipe for failure.
- If you are unsure, do you trade anyway? Executing a bad trade is worse than not trading at all. The excitement of making a trade that does not make sense makes no sense.
- When you have a losing trade, what is your reaction? If you follow your trading discipline and close the trade you have your emotions under control. On the other hand, if you change your mind and begin to hope for a better outcome, you are losing control, setting the stage for a larger loss.
The best traders never let their emotions enter into their trading. When they suspect their heart is overruling their mind, they stop until the feeling passes. It serves them well and can do the same for you.
The Bottom Line
Trading futures is fraught with risk. Since the vast majority of futures traders fail to make consistent profits, anyone who is considering trading futures should take a step back and ask themselves a number of questions before proceeding. If after careful consideration, you wish to proceed, do so knowing that you are embarking on an exciting venture that will test your trading discipline to the utmost.