Futures trading is a more interesting and functional way to earn on existing capital than investing in stocks, currencies, real estate, etc. The tool is remarkable in that it gives an extensive selection of strategies. As a special type of transactions, futures are popular in the financial market. They bring significant profit with a skillful approach.
- How does the futures market work?
- Benefits of futures trading
- Considerations before trading
- Choosing a Brokerage Firm
- Categories of futures markets
- Types of transactions in the futures market
- The most investment-attractive futures
- Preliminary market analysis
- Opening a trading account
- Contract classification
- Trading algorithm
- Margin and financial result
- Common newbie questions
How does the futures market work?
Futures trading involves forecasting market dynamics in order to buy / sell assets at a favorable rate. A feature of the financial instrument is:
- Stability. Futures is a kind of contract concluded on the stock exchange, where, along with all the conditions, the price and delivery time of the goods are approved in advance. In simple terms, the buyer undertakes to buy a contingent asset at a fixed price after a certain period of time. Further, the investor is as lucky. If the price of the commodity rises within the specified period, he will make a profit. If it falls, it will be at a loss. In the best case, none of the parties to the agreement will make a profit and suffer no losses (each remains “with his own”).
- Compulsory performance of the contract . The purchase and sale of assets after the expiration of the contract is an obligation, not a right, of the parties. The stock exchange acts as a guarantor of the fulfillment of the requirements. Before the conclusion of the transaction, an insurance premium (guarantee) is collected from the participants. Usually it is 5% of the contract amount. Additionally, there are penalties.
- Variety of objects. There is no specific framework for choosing the object of the transaction. It is possible to conditionally buy / sell securities, interest rates, currencies, indices, etc.
Financial experts classify futures trading as speculation. Real investment involves investing money in the purchase of a particular object. A futures deal is compared to a bet, i.e. the participants conditionally make bets whether the price of an object will fall or rise.
Benefits of futures trading
The financial instrument is actively used by those who want to earn extra money easily and quickly. Some investors believe that its advantages outweigh the disadvantages. Positive sides:
- There are many different assets available up to the commodity markets. Portfolio diversification is easier.
- Selling short positions is unlimited. The sale of assets that the seller does not have is called “short” – a short sale. If compared with stocks, then during the time allotted for the sale of the product, it is possible to buy / sell futures several times.
- High level of liquidity. Futures is a derivatives market instrument. The execution of the contract takes place in a short period of time. The chance of price growth increases, i.e. the probability of receiving income is higher than with long-term investments.
- Standard form. Trade participants do not need to discuss the specifics of the contract. All conditions are already provided.
- The entry threshold is low. Payment by agreement does not have to be made immediately. Enough to bring insurance. The limit is approximately 15% of the total transaction value. The rest of the amount is prepared for payment at the end of the contract. In addition, due to the virtuality of the object of the contract, there is no need to pay the broker for the storage of securities. A futures deal is just a designation of a position in the fund’s base.
- Possibility to continue trading after the end of the main section. To do this, there is an urgent section that extends the process for a few more hours.
The disadvantage of this type of investment is the lack of leverage, i.e. you cannot ask the broker for a loan of money or the investment object itself. The reason is the absence of the need to have the entire amount on the account at once at the beginning of the transaction. And the ephemerality of the object does not allow you to owe something that does not exist. Another negative side is that a trader, when applying for the purchase of an object, does not know who will become the second participant. This increases the level of risk.
With all the abundance of advantages, the tool is not recommended for use by beginners. Futures trading turns into a casino without sufficient knowledge and experience in the financial market. Beginners get the impression that it is easy to “guess” the dynamics of price fluctuations.
The provision of special conditions for the payment of futures contracts does not allow using the broker’s lending services. Accordingly, it is impossible to talk about the availability of leverage for this type of investment. Leverage was replaced by collateral. An investor has the right to buy a futures contract without even having the entire amount. The exchange personifies the guarantor of compliance with the rules, and requires only a part of the amount to be paid (advance payment). This is GO (collateral or deposit).
Considerations before trading
Before trading futures, make sure you understand and fully understand all the risks associated with such trading. Next, you need to take a number of actions: choose a broker, determine the market segment and individually select the type of future trading for yourself.
Choosing a Brokerage Firm
A broker specializing in this type of investment will give the trader the highest level of service and recommendations. However, for private investors, this can be costly. A better option would be to choose a discount set of services for a small fee. Choose a brokerage firm based on the following indicators:
- betting commissions;
- margin requirements (initial rate);
- available types of transactions;
- platform software;
- convenience of the monitoring interface from the user’s point of view;
- the speed and quality of the broker’s work when serving other clients.
Categories of futures markets
When trading stocks, many different industries are available (from technology to foreign currency bank deposits). With similar trading mechanics for industry categories, there are still nuances for their individual varieties. The situation is similar with futures trading. Despite the similarity of futures transactions, such a wide range of instruments is monitored that it is necessary to monitor all kinds of categories. Compare them with promotional trade contracts for a more subtle understanding of what happens when choosing a spectrum for work. Keep in mind that each of the markets (metals, currencies, energy resources, etc.) has characteristic nuances: the difference in liquidity levels, contract volumes, margin requirements.
Types of transactions in the futures market
Buying a contract or selling it, hoping to win on the rise / fall of the price, is the easiest type of transaction to understand. It is with this kind of transactions that you should start trading in the futures market. As you learn and get involved in the process, use other more complex methods. Transaction types:
- Bet on positions at the prices of the contract and the product itself. A trader establishes a long position in the futures market and at the same time a short position in the financial market. The essence of the bet is the fluctuation of prices for the commodity itself and the prices for its futures. The total profit from both positions will vary. The trader is interested in closing both positions, being in the black.
- Bet on contract positions. The essence of the bet is to change the difference between the prices of two contracts. The operation logic is similar to the previous one.
- Using futures trading against a stock market decline. Otherwise, hedging. Figuratively, it looks like this: the client has a large block of shares, and does not want to sell them. The financial market is pressing with the possibility of a sharp drop in prices. The way out will be their sale in the form of a futures contract. That is, futures become insurance against falling prices in the stock market.
The most investment-attractive futures
Whether we are talking about domestic or foreign sites, the principle is unchanged. The greatest volatility (price volatility) and liquidity (the ability to quickly convert assets into cash at a good price) are always characteristic of popular market indices. Currency bets (euro to dollar, Swiss franc to Japanese yen, etc.) are also liquid and volatile. Their essence is comparable to indices, but bets are easier to understand.
Transactions that are less risky are:
- acquisition of futures for shares of large and successful corporations;
- trading futures for precious metals.
Preliminary market analysis
For the correct choice of a contract for futures, it is obvious that it is expedient to study the current situation on the market. Below are the most effective and common types of analysis among traders.
The study examines indicators of different scales that affect contract prices in the future. Since the futures price correlates with the price of its underlying asset, all factors that can affect the ratio of the supply-demand balance and the underlying asset are analyzed. Examples:
- Currency futures. Here, the indicators of popular markets like FOREX, in particular the levels of interest rates, inflationary fluctuations in countries with the corresponding national currencies, economic news, and spontaneous factors have a special influence.
- Stock and bond futures. The main role in this sector is played by data from the reporting on the entire financial movement of the issuing company (issuing securities). Particular attention is paid to fundamental ratios (indicators of the company’s growth, net revenue at the moment and in dynamics, etc.).
The analysis is based on data from price charts. The principle of this method is to establish that the price changes at any point in time. Even if there is no change on the chart, when scaling to the expansion of the boundaries or their narrowing, such stability is a pause before the price rises or falls. A significant role in the analysis is played by:
- patterns (patterns of price changes in past stages);
- support and resistance levels (insurmountable barriers to price over a long period of time).
The combination of these and other indicators gives reason to conclude that the transaction is worthwhile. All data is built on the basis of the price fluctuation chart.
Opening a trading account
Without exception, all stock exchanges provide the possibility of futures trading. The work begins with opening a brokerage account:
- The choice of an intermediary company in trade is based on the study of the terms of the contract. Check the broker’s license on the website of the Moscow Interbank Currency Exchange MICEX (https://www.moex.com/).
- The documents required to open an account vary slightly depending on the specific organization, but the main list is as follows:
- application according to the model established by the organization;
- passport / other identity document;
- TIN certificate;
Decide on the amount to transfer to the account. For different brokers, the minimum entry threshold varies significantly. Next, do the following:
- Choose which account to open – a regular one (taxation of 13%) or an individual account (IIA) (here you can choose the type of tax deduction – for a contribution or for income).
- Choose a tariff plan, taking into account all the proposed financial activities.
- Determine a convenient way to open – visit the company’s office in person or by registering online. In the first case, it is enough to bring a package of documents. The specialist will do the rest. In the second, you will have to fill in all the necessary columns yourself. Registration confirmation is carried out through identification through the “Gosuslugi” or SMS confirmation.
- Documents are processed within 2-3 days. After the expiration of the period, an SMS message will be sent to the specified phone number with a notification about opening an account.
- The account is not active until the first deposit. Replenish it with a bank card, transfer from savings accounts, cash.
An active trading account allows you to start buying and selling futures.
The technology of interaction with it also depends on the type of the selected contract. Before you start trading, carefully study the characteristics of both types.
- Delivery. The very name of the type of contract speaks of its essence – it is supposed to be the actual delivery of a product based on the results of the transaction. Compliance with the agreement is controlled by the exchange, punishing participants with fines in case of violation of the conditions. The type is used, as a rule, by agricultural and industrial enterprises. Interest is explained by the need to profitably purchase the raw materials themselves or other goods needed in production.
- Estimated. The terms of the contract concluded under this type do not provide for the delivery of the object of the agreement. The transaction is carried out on the basis of a monetary exchange. Basically, settlement agreements are practiced by traders to generate income through speculative transactions.
Transactions on the stock exchange are not made thoughtlessly. Futures trading requires a clear action plan that varies from situation to situation, but has the main backbone – a trading algorithm:
- Determining the value of the contract at the current moment.
- Assessment of the amount of the insurance premium (GO).
- Calculation of the number of available contracts by dividing the amount of the deposit by the size of the margin.
Example: You want to know the number of gold futures contracts available for purchase with deposits of 1, 5 and 10 thousand dollars. Calculations are approximate due to the volatility of trading parameters. The following data is available:
- the cost of a troy ounce is currently 1,268 thousand dollars;
- GO 0.109 thousand dollars.
To calculate the number of contracts of different deposit sizes, the deposit amount is divided by the amount of GO:
|Deposit in thousands of dollars||one||5||ten|
|Calculation||1000 / 0.109||5,000 / 0.109||10,000 / 0.109|
|Number of contracts||9||45||91|
You need to be aware of the risk. A reasonable approach is to limit the risk to 3% of the deposit.
Margin and financial result
An open position is a purchased futures. At the end of the day, margin is accrued on its position (the difference between the purchase price and the value at the end of trading).
By the time the contract is closed, this indicator contains information on daily accruals, being an indicator of the financial result of the transaction.
Experienced traders make a preliminary calculation of the profitability of the transaction (variation margin). This allows you not to miss the best moment to close the position. Profitability is calculated by the formula: VM = (Pn − Pn-1) × N, where:
- Pn is the value of the contract in the present period of time;
- Pn-1 — asset value at the end of the previous trading day;
- N is the number of contracts.
Common newbie questions
The more a novice financial figure is immersed in the topic of interest to him, the more questions become relevant for him. This expands the horizon of knowledge. Below are the most common questions among newbies:
- Where can I see a list of all current futures? Licensed exchanges display a list of available futures contracts in real time. Any exchange on which a trader operates is interested in timely updating of the lists.
- Where can I download the quote history? On any exchange there is a service with an archive of quotes. To do this, you can use the search on the site by entering “Quotes Archive” in the search box. Sometimes you can download quotes directly through the charting service by setting the “Maximum bars” parameter based on the fact that 1 day is equal to 1440 minutes. Before downloading, the user is prompted to select the beginning and end of the time period of interest.
- How to choose the right futures date? The choice of the expiration date (the day the contract expires) depends on the underlying asset. Occurs on certain days set by the exchanges. The trader’s choice lies in the fact that when making a decision to conclude a transaction, an analysis is required based on the type of asset. That is, the choice of the date of the futures is part of the general preliminary analysis of the market, which is described above.
- What happens on the last day of trading? On this day, the exchange conducts recalculations for all open positions in the futures market, i.e. this is the day the obligations under the contract are fulfilled. It is almost impossible to predict the behavior of the market on this day. Traders need to be extra vigilant on closing dates so that unexpected volatility does not lead to losses. In addition, it is on the last day of trading that you can “hit the jackpot”.
- Are there perpetual futures? Yes, there are futures with no expiration date. Under such contracts, the recalculation is made hourly. Those who hold long positions (longs) pay those who hold short (shorts) at a rate determined by the exchange. This phenomenon owes its existence to the need to maintain the value of perpetual futures without closing a position. This value should be at the level of the base price for the indices.
- What is the difference between short and long positions in a contract? Short – the result of the sale of the contract. The owner of a short position has an obligation to sell the underlying asset at the price agreed in the contract. Long — the result of buying a contract. Its owner has an obligation to buy the underlying asset on the expiration date of the contract at the price set for it.
- Do investors need futures? Each investor decides for himself whether he needs to trade in the futures market. The choice of financial instruments depends on the personal preferences, knowledge and wallet of the investor. Some people do not use futures trading as the only financial instrument. Rather, they consider futures as one of the options for capital diversification. It is a risk mitigation tool. It consists of investments in various assets.
You can learn how to trade futures and earn income in the following video: https://www.youtube.com/watch?v=csSZvzVJ4I0&ab_channel=RamyZaycman Futures, as an exchange instrument, has not always played a speculative role. Through a futures transaction, suppliers (farms, factories, etc.) protected themselves from price changes. Now futures trading has gained incredible scope and popularity. It is better to start this kind of financial activity with experience in trading in the stock markets.