How to Trade Futures: A Complete Guide for Beginners

Futures trading is a high-leverage, fast-paced market where skilled traders can navigate its risks and rewards. It’s not for the faint-hearted, but with the right preparation, anyone can learn to trade futures successfully. It likely won’t be something you’re immediately successful at, but with the right practice and mentality, you can master futures trading.

I’ll briefly walk you through the basics of futures trading, its advantages and disadvantages, strategies to help you get started, and essential tips for managing risks effectively.

What is Futures Trading?

Futures trading involves contracts that obligate the buyer or seller to transact an asset at a predetermined price on a specific date in the future. These are derivative financial instruments, meaning their value is tied to an underlying asset like oil, gold, stock indices, or even cryptocurrencies.

When trading futures, you don’t necessarily own the asset. Instead, you speculate on whether its price will rise or fall. Futures contracts are standardized and traded on regulated exchanges like the Chicago Mercantile Exchange (CME), ensuring transparency and liquidity.

Key Features of Futures Trading:

1. Leverage: Futures are traded on margin, allowing traders to control large positions with a fraction of the total value.
2. Two Main Positions:
   • Going Long: Buy a futures contract, betting the price will rise.
   • Going Short: Sell a futures contract, betting the price will fall.
3. Marked-to-Market: Profits and losses are calculated daily, requiring traders to manage their positions actively.

Why Trade Futures?

Futures trading offers unique benefits that make it appealing to many traders, especially those looking to day trade or hedge their investments.

Advantages:

• No PDT Rule: Unlike stocks, you can day trade futures regardless of your account size, avoiding the $25,000 minimum rule for U.S. residents.
• Short Selling Built-In: You can profit from declining markets without borrowing fees.
• High Leverage: Control large positions with relatively small deposits, maximizing your capital’s potential.
• Extended Trading Hours: Trade nearly 24/7, giving you flexibility to respond to global events.
• High Liquidity: Popular contracts, like the E-mini S&P 500, often trade millions of contracts daily.

Disadvantages:

• High Risk: Leverage amplifies both gains and losses, making it essential to manage risk effectively.
• Complexity: Futures trading requires a good understanding of contracts, pricing, and market behavior.
• Contract Expirations: Traders must manage or roll over positions before contracts expire to avoid unwanted physical delivery.
• Fees: Unlike stocks and options trades that are now free or close-to-free to trade, with futures you’ll have to pay commissions to your broker and the exchange.
• Data Costs: Data isn’t free, and for most platforms, you will need to pay for live data for each exchange you wish to receive data for.

How to Start Trading Futures

1. Understand the Basics

Before you dive in, familiarize yourself with how futures work. Research contract specifications, margin requirements, and the risks involved in trading on leverage. I typically want to know what are the trading hours for that contract and how much I can make or lose per tick.

2. Choose a Broker, Platform and Data source

This is probably one of the most confusing parts of futures trading, there are all-in-one solutions such as ThinkOrSwim, which include the broker, platform, and data source. Unfortunately for futures traders ThinkOrSwim leaves a lot to be desired in terms of customizability, charts, orderflow and data-access. This is why it’s best to separate the platform+data from the broker.

Select a broker that aligns with your needs. Look for:

• A broker that will support the platform you intend to use.
• Competitive fees and commissions. These are often negotiable.
• Mobile apps for trading on the go. This can be difficult to find but there are some brokers and/or platforms that support mobile.
• Regulated and reputable services, remember, you will be entrusting your hard-earned money to your broker.

Our recommended broker is EdgeClear, we’ve been with them for years and there’s never been a problem. They’ve always been clear on their communications and I also appreciate the margin they offer, this way you can trade more contracts for less money.

There are many platforms out there; some are web-based, and others are strictly PC or Mac-compatible. At Sierra Trading, we use Sierra Chart because of its high performance, low latency, and customizability, which can be crucial when running dozens of charts with different indicators. I will cover Sierra Chart as a platform in another post.

Depending on the combination of broker and platform you’ve chosen, you will have different data options, for example, if you choose EdgeClear as your broker and Sierra Chart as your platform, you could pay Sierra Chart for data through their website using their Denali feed (extremely performant) or you could pay your broker for data and only pay Sierra Chart for the platform.

3. Set Realistic Capital Requirements

Determine your starting capital based on:

• The initial margin required to open positions.
• A buffer for drawdowns (e.g., 10 losing trades in a row).
• Example: For a Micro E-mini Nasdaq Futures contract requiring $3,224.60 margin, a trader might start with at least $5,224.60 to include drawdown coverage. As mentioned above, with the right broker they can have different margin requirements, which could be as low as $300 for some but more often you’ll find a margin requirement of $500. With an account of $5,000 dollars you could be trading 10 contracts.

4. Practice with Simulators

I know how much we all want to start trading when we first learn about futures trading, it’s exciting and as humans, we tend to have little self-control. Unfortunately, self-control is as important as learning the right strategies to trade. Therefore, I cannot recommend enough that you paper trade for at least 6 months, yes you read that right 6 months. You can avoid losing many thousands of dollars if you just paper trade at first.

Use paper trading accounts to practice strategies without risking real money. Simulators help you understand platform functionality and refine your trading approach.

Risk Management in Futures Trading

Risk management is the cornerstone of successful futures trading. Here’s how to protect your account:

• Position Sizing: Calculate how much capital to allocate based on the contract’s point value and your risk tolerance.
• Use Stop-Loss Orders: To automatically close positions when prices move against you beyond a set limit.
• Limit Leverage: Start small and increase your exposure gradually.

Trading Strategies for Beginners

1. Scalping: Make quick trades, holding positions for seconds or minutes to profit from small price movements.
2. Day Trading: Open and close positions within the same day to avoid overnight risks.
3. Swing Trading: Hold positions for days or weeks, riding medium-term trends.
4. Momentum Strategy (Beginner-Friendly):
   • Identify when a trend forms.
   • Enter long or short positions based on trend direction.
   • Set stop-loss and profit targets to manage risk.

Key Futures Contracts by Asset Class

Futures contracts exist across various markets. Here are some popular options:

• Stock Index Futures:
  • E-mini S&P 500 (ES): $50 per point, 0.25-point tick size = $12.50.
  • Micro E-mini Nasdaq 100 (MNQ): $2 per point, 0.25-point tick size = $0.50.
• Commodity Futures:
  • Crude Oil (CL): $1 per barrel, $0.01 tick size = $10.
  • Gold (GC): $100 per point, 0.1-point tick size = $10.
• Currency Futures:
  • Euro FX (6E): $125,000 per contract, 0.0001 tick size = $12.50.
• Cryptocurrency Futures:
  • CME Bitcoin Futures: $25 per point, 5-point tick size = $25.

Common Mistakes and Tips for Success

• Mistake #1: Overleveraging positions without considering risks.
  • Tip: Start with Micro contracts to limit exposure.
• Mistake #2: Emotional trading after losses.
  • Tip: Stick to a predefined strategy and maintain discipline.
• Mistake #3: Ignoring fees and slippage.
  • Tip: Choose brokers with transparent pricing and trade in liquid markets.

There are many, many more mistakes that one can only learn by doing, and this is why it’s important to begin your futures trading journey in a simulated account.

 

Futures trading offers incredible potential for those willing to invest time in learning and practicing. By understanding the market, managing risks, and sticking to a strategy, you can navigate this challenging but rewarding financial instrument effectively. At Sierra Trading we offer different studies and indicators that can aid your trading regardless of which market you choose to trade.