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Futures are agreements on buying or selling a certain product at a certain price at a certain date in the future, designed initially in order to…
Futures are agreements on buying or selling a certain product at a certain price at a certain date in the future, designed initially in order to protect both farmers and buyers from volatile prices for crops months ahead of harvesting. Unlike a stock that represents ownership in a company, futures are obligations connected to a future transaction, applied to various assets from oil to wheat, from indexes to currencies. Most traders today use futures not for getting a certain product but as instruments for price speculation, making the use of them absolutely different from the original purpose of creation.
To buy a certain contract, the trader needs to pay only a small part of its cost in the form of margin. This means that a small price movement can result in a percentage profit or loss that is much higher than the trader's actual account size. The possibility to get such results due to the leverage is the key difference of futures from the direct purchase of a stock where the trader risks only its cost, while the maximum possible loss in futures can be higher than the trader's margin.
If the price movement leads to the erosion of the trader's margin to the level that is lower than the required one, the broker issues a margin call, asking for extra money from the trader immediately or closing the position automatically, often at a loss. As futures markets tend to move quickly and operate almost non-stop, it can happen in minutes, leaving a trader almost no time to react to that even being on watch. It is crucial to understand how the mechanism works before opening any futures position because it is the main factor by which one wrong trade can seriously harm the account of a trader.
Futures contracts can be divided into a few broad groups: commodities (oil, gold, agricultural), financial (stock indexes, interest rates) and currency futures (exchange rates). Different types of futures differ dramatically in behavior, volatility and the factors that influence their price movement, for example, agricultural futures react to weather and harvest news while stock index futures ignore these influences. Understanding the type of market that is traded by a trader and the factors influencing its price movement is more important than any generic trading techniques ignoring these factors.
Each futures contract has a certain expiration date after which the contract can settle in cash or require delivery of the underlying asset, representing a crucial difference from a stock that can be held forever. Traders that want to continue holding the contract beyond its expiration date should "roll it" to a new contract with a later expiration date, which is a deliberate action that stock investors do not need to make. Failure to pay attention to the expiration dates is a really avoidable mistake leading to an unwanted delivery of the underlying asset or forced premature closing of the position.
The most serious study based on the research of the performance of thousands of individual traders holding equity index futures over several years revealed that around 97% of them lost money by the end of 300+ days trading period with only 1% of them gaining more than minimum wage. Similar data is published by regulators of several countries requiring their brokers to publish account performance statistics, and the number of retail accounts losing money in the leverage products is around seventy to ninety percent. This is not the reason to believe that nobody should trade futures, but it is an important number to consider before thinking about futures trading as a source of income.
Risking only a small fixed percentage of the total account balance for each trade, usually estimated to one or two percent, allows avoiding the major loss due to one losing position even in the inevitable losing period. Setting a predetermined stop-loss (an exit point of the position chosen by a trader before the opening of the position and executed automatically in case of reaching the stop-loss level) prevents emotional decision-making and turning of a manageable loss into a bigger one. Both of these measures do not guarantee profits but seriously change the situation of survival after losing trades that will happen to every trader.
Trading on a virtual account with real market prices but without the risk of losing money allows to learn the platform mechanics, test reaction to a losing position and develop understanding of how fast the leveraged positions can move, avoiding the financial risk. Most of the new traders neglect this stage due to impatience to start real trading and suffer financial losses that are not only losses but also the lessons of using the platform. Viewing a reasonable paper trading period as a requirement instead of some formalities allows separating people that trade successfully from others.
Trading futures requires constant attention, the real ability to withstand losses exceeding the initial deposit and the sufficient capital to allow losses even in case of a losing streak that would not harm the financial stability of a trader, which makes it a fundamentally different activity from long-term investing in stocks or funds. If the trader's goal is the steady growth of wealth during many years, the simpler and less leveraged strategies prove themselves much better for most people than active futures trading. This is a legitimate financial tool with documented applications but the trader should be really honest about his/her goals before putting money on it.