How to Make Money Trading Futures As a Beginner
A futures contract is an agreement to buy or sell an asset at a future date and at an agreed-upon price. Learn how beginners can succeed and profit from futures trading.
What Are Futures Contracts
A futures contract is a legally binding agreement to buy or sell a standardized asset on a specific date or during a specific month. Standardized assets can be stock market indices, agricultural commodities, animal products, energy, and metals. Futures contracts were originally created to allow businesses to secure a specific market price and to protect against adverse price swings in the future.
Consider the following example to illustrate how futures contracts work:
- An airline company wants to avoid an unexpected price increase and lock in jet fuel prices can buy futures contracts that guarantee jet fuel delivery in the future at a specified price.
- A fuel vendor can sell futures contracts to ensure that it has predictable revenues for fuel, and to protect against an unexpected decline in prices.
- Both sides agree on specific terms: To buy or sell 1,000 barrels of fuel, delivering them in 90 days at a price of $60 per barrel.
In this example, both parties use the futures market to manage their exposure and risk to market price changes.
Not everyone wants to purchase physical commodities in the future. Many seek to make money off of price movements. These types of traders buy and sell futures contracts with no intention of taking delivery of the underlying commodity. They roll to the next front-month contract or close their position before delivery is due.
With traders, hedgers, and many other market participants involved in buying and selling pursuing different interests, there is a highly liquid market for these contracts.
Most trading activity is now conducted electronically but they originally traded in open outcry pits on the trading floor. The mainstream image of a floor trader crying out his lungs is therefore outdated.
Electronic contracts (also called ‘E-mini’) are smaller in value than their pit-traded counterparts. E-minis became so popular that their trading volumes exceeded those of the regular, full-sized futures contracts. Hedging strategies still dominate the trading activity and ideally, futures contracts should also be utilized as such.
How Profitable is Futures Trading
Most traders are attracted to the futures market because they can borrow a substantial amount of money to magnify relatively small price movements. This kind of trading is called margin trading as traders deposit only a fraction of a contract’s value on their brokerage account to trade with a 10:1 or even 20:1 leverage.
The instrument we trade here is the E-mini Nasdaq-100 (NQ) which has a multiplier of $20. If the underlying Nasdaq-100 index moves 10 points, your gain or loss in the NQ is going to be $200 per contract (20 times).
Smaller accounts can be traded with the new Micro E-mini Nasdaq-100 (MNQ) which only has a multiplier of $2 (one-tenth of the size of NQ).
Margin requirements determined by the exchange are roughly 6%, so you only need to deposit $16,000 to trade one NQ contract or $1,600 to trade one MNQ contract.
While using leverage can potentially create immense profits, trading on margin also increases risk: If the Nasdaq-100 moves against you, it will do so more dramatically than you may be able to handle.
The greater the leverage, the greater the gains but the greater the potential loss. Your broker may decide that it can’t tolerate a loss any longer and close your position. This event is a margin call. Margin calls are entirely automated nowadays, but the term comes from the days when your broker still had to call you to ask for more deposits or otherwise to close you out.
Beginners should understand the implications of leverage before they put on a trade as this could bring emotional havoc. Emotions are a neglected factor but play a critical role in your profitability. If gains and losses are beyond what you can normally handle, you may make emotional-based trading decisions.
Does It Take Long to Become Profitable
Some brokerages allow you to open up a paper trading account. You can practice trading with paper money before you commit real money to your first trade. This is a great way to get a first feel for futures contracts, and how leverage and commissions impact your trading performance.
If you’re just getting started, spend a few weeks trading in a paper account until you’re sure you have the hang of it.
Beginners generally have a strong will to succeed on their own. Two determining factors can make or break a futures trader: Intellect and emotion.
An ability to identify universal rules that work under all market conditions is mostly a matter of intellect. It will take you less time to make profitable trades. It’s advisable to follow a rule-based trading strategy and not to trade out of gut feel.
Emotions are much harder to overcome because every individual behaves differently and has a different tolerance for risk. While you can come up with a few trading rules rather fast, following through with them and becoming consistently profitable can take years to master.
It should be mentioned that most traders won’t reach profitability and will waste a lot of time and money finding that out. Many have a day job and can’t spend time or energy watching the market all day long in order to develop a trading strategy.
Seeking mentorship from someone with a solid track record is a great way to succeed.
Published Mon Apr 12 2021 (last modified Fri Jan 26 2024)