Futures trading can offer plenty of opportunities, but, as with any form of trading, there are risks involved. It forms a key strategic element for millions of traders around the world, so it's important to understand what it is, how it works and the associated pros and cons. Read on to find out more in our guide to trading futures. Please note that apart from our CFDs with futures as the underlying asset, you cannot trade futures with Tradu and this article is for informational purposes only.
Futures trading refers to the buying or selling of a futures contract. A futures contract is where two parties – a buyer and a seller – enter into an agreement to buy/sell an asset at a certain price at a set date in the future (hence the name). They can agree to exchange before that point if they wish, but both parties are obligated to buy/sell at the pre-determined price if the position is held until the expiry date is reached.
You can trade futures using derivatives, which means you are speculating on an asset's price movement but not taking ownership of the asset. For example, you might trade energy futures by predicting fluctuations in oil prices but you won't take physical ownership of the oil itself.
Trading futures and trading options works in a very similar way. You are agreeing to buy or sell at an agreed price at a specified point in the future. But when you trade futures, there is an obligation to exchange upon the expiry of the contract. With options, you have the right to buy or sell at that time, but there is no obligation. You simply have the option – hence the name.
The main difference between futures and forwards is their regulation. Futures are standardised agreements that can be traded on an exchange with pre-defined specifications. Forwards, on the other hand, are traded over the counter. The details of the agreement are set by the buyer and the seller, not a centralised body, so regulation is less stringent.
Let's use oil futures as our example and assume that a contract is trading at $80 for 1,000 barrels:
The above is an illustrative example. The length of futures contracts can vary, so it's important to check the specifications before you enter into any position.
You can trade futures via spread betting and contracts for difference (CFDs). These are financial derivatives that mean you do not have to take ownership of the underlying asset e.g. 1,000 barrels of oil. Instead, you are merely speculating on the future price movements of that asset.
CFDs are an agreement to exchange the difference in price of an asset between when the contract is opened and when it is closed. Unlike futures contracts, there is no pre-determined price or date at which you are obligated to buy or sell.
Spread betting works slightly differently to CFDs in that your profits and losses are calculated per point of price movement. Both are leveraged products which allow you to trade futures on margin, and you can find more information below.
Trading futures with leverage allows you to increase your market exposure from smaller deposits. It essentially involves putting up only a proportion of the required capital and borrowing the remainder from your broker.
The deposit you put up – known as margin – could be 5, 10 or 20% of the full value of your position. That percentage will vary depending on your broker and the assets you wish to trade. It will usually be displayed as a leverage ratio, with a 10% margin displayed as 10:1, for example.
The advantage of trading futures with leverage is that you could magnify your profits from a relatively small outlay. If we use the oil futures example outlined above:
However, the risk of using leverage in futures trading is that your losses can be magnified too. That's because you are exposed for the full value of your position, not just your deposit amount. So, in this instance, your net losses would be $12,000 – your initial $8,000 margin plus the $4,000 loss on the trade.
Historically, futures contracts were used to buy and sell agricultural commodities such as coffee, sugar, timber and livestock. However, the emergence of financial markets means you can trade futures in a wide range of asset classes, including:
There are a few different ways to approach futures trading, so you need to settle on a strategy – or strategies – that work for you. Common examples include:
There are many reasons why trading in futures is such popular practice around the world. Here are the primary benefits:
Please note that apart from our CFDs with futures as the underlying asset, you cannot trade futures with Tradu and this article is for informational purposes only.