You’ve decided that you want to give futures trading a try. Perhaps you’ve had experience trading stocks, options, or foreign exchange, and you want to try your hand in commodities trading. You’re aware of the high leverage in futures trading and the potentially high profits and losses that you can experience when trading commodities. Nevertheless, you believe that you have adequate levels of risk capital to take on this endeavor.
The only thing getting in your way is the limitation of being a newbie:
- Where should you start?
- How do you begin to get a grasp of such a large market and industry?
- What might you absolutely need to know before you start?
- What are the things to avoid?
We can help you navigate this beginning phase. We will give you an outline of the basic areas of knowledge that you should cover. It won’t be exhaustive (that’s where your own homework starts), but it will provide you with an adequate map. Next, we’ll give you a more comprehensive treatment of the information for free. Just go on our site and download our Introduction to Futures Trading eBook and use it as a reference.
Let’s get started.
Understand Commodity Fundamentals
If you are going to trade commodities, you must at least understand something about the fundamental dynamics that drive that market. Otherwise, you risk getting sideswiped by fundamental events.
Even if you are a strictly technical trader, it would be advisable to understand the fundamentals as a strategic backdrop to the technically-driven tactics you implement in the markets.
Know the Difference Between Speculators and Hedgers
Not all commodity trades are speculators. This may seem obvious to anyone who has been trading futures for some time, but it’s not well understood by many beginning futures traders.
Speculators make up a large majority of certain markets, but not all. Speculators seek to engage risk for profit, while hedgers seek to mitigate risk. The difference between speculative, institutional, and commercial positions are also viewable in the CFTC’s Commitment of Traders report. But you have to know what these three “entities” are before you can use the data to inform your trading decisions.
Know Your Exchanges
If you are going to assume the risks of buying and selling highly leveraged instruments, it makes sense to know on which exchange you are buying and selling. It also helps to know the instruments that the different exchanges offer, the fees they charge for trading certain instruments, their margin requirements, their guidelines and rules, and their opening and closing hours.
It also helps to know who regulates these exchanges, and what to do if you end up with a trading dispute.
Know the Elements of a Futures Contract
How much does your contract of choice gain or lose in dollar terms per tick, or per point? Is there a difference between a tick and a point? Do you know which contract month has higher trading volume or when your contract expires? Do you know when to roll over your contract? Do you know how to read contract and monthly symbols?
These are all important things that have stumped beginning traders; often at a cost. Don’t let it happen to you. Know these things before you begin trading.
Understand How Margin and Leverage Works
Every time you open a futures position, you are trading on borrowed money. You may have been able to open an emini-S&P contract for as little as $500, but you are responsible for the entire amount until you close your position (or unless your position gets liquidated by your broker if you fall under margin).
Do you know what that entire amount is and how to calculate it? If not, you’d better find out.
You can lose more than you have in your account when trading futures. That’s because you are trading on margin. And believe me, you do not want to find yourself in that position.
Know the Difference Between Liquid and Illiquid Markets
Should you trade the emini-S&P or emini Midcap S&P? Should you trade crude oil or RBOB gasoline? Corn or rough rice? It all depends on what you are trying to achieve. The difference between these contracts go beyond the underlying commodities on which they are based. There’s also a huge difference in liquidity.
The last thing you’ll want to do is to get stuck in a market that you cannot exit, or to enter a market with a large loss due to slippage due to lack of liquidity.
Know How Your Commissions Are Calculated
How much are you getting charged for commissions? What are data fees, exchange fees, transaction fees? Why are you paying platform fees, routing fees, charting fees?
Where do these fees go: to the broker, platform provider, FCM, exchange, regulators…? Do you need all the technologies that come with fees? Many of these fees may be considered “the cost of doing business,” but like every responsible business person, understand your costs!
Understand How Fundamentals and Technicals Affect One Another
Many technical traders will assume that all fundamental information is reflected in the technical movements of price. If that were true, why do experienced technical traders cease trading during certain economic releases?
It’s because fundamentals often affect technicals, and vice-versa. Know the difference, and understand when to pay attention to one or the other, or both.
Do Your Final Gut Check
Is futures trading really for you? Do you have the risk capital to withstand drawdown and losses? Do you have a clear trading plan? Do you know your market well enough to implement your plan?
Futures trading isn’t for everybody. No matter how sound your analysis may be or how well your strategy has performed, past performance is does not necessarily guarantee future results. That may be true of all investments, but you need to understand that the leverage involved in futures can significantly increase both profits and losses. You can lose more than you have in your trading account.
So know your markets well, and proceed cautiously.
Read Our Free Introduction to Futures Trading E-Book. Our e-book provides a more comprehensive perspective on all of the topics we just mentioned above. To download it, click here.
To trade in a simulated environment, feel free to request a trading demo.
The risk of loss in the trading of stocks, options, futures, forex, foreign equities, and bonds can be substantial and is not suitable for all investors. For a copy of “Characteristics and Risks of Standardized Options” visit http://www.theocc.com/about/publications/character-risks.jsp Trading on margin or the use of leverage is not suitable for all investors and losses exceeding your initial deposit is possible. Supporting documentation is available upon request.
Trading Futures, Options on Futures, and Forex involves substantial risk of loss and is not suitable for all investors. Carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment and only risk capital should be used. Opinions, market data, and recommendations are subject to change at any time. The lower the margin used the higher the leverage and therefore increases your risk. Past performance is not necessarily indicative of future results.