Futures are similar to stocks, but they require an entirely different skillset. New investors often get excited about the prospect of futures trading, given the high potential upside, but they underestimate the requirements for trading futures successfully.
The Basics of Futures Trading
First, you should understand the basics of futures trading, and why it’s such an attractive strategy to new and experienced investors alike. Essentially, futures are a kind of contract that require the parties involved to exchange an asset at a fixed price on a fixed date in the future, regardless of the current price of that asset. For example, commodity futures are common; if today, the price of crude oil is $65 a barrel, you could buy a futures contract to buy oil in December for $75 a barrel. If the price of oil goes up to $100 a barrel, you’ll essentially get to buy oil at a very cheap discount. You could also contract to sell oil in December at $65 a barrel, and if it drops to $50 a barrel, you could make a substantial profit.
Futures trading is attractive because you can take advantage of financial leverage, trading in quantities greater than you’d otherwise have access to. It also allows you to execute trades based on your prediction of future events.
How to Be Successful Trading Futures
These tips can help you become a successful futures trader:
- Choose the right broker. Choosing the right futures broker can make your decisions considerably easier. Your trading platform should be easy to navigate, and full of valuable information that can make your trading decisions more thorough. You should also have access to reliable availability—and service if you have a question about a trade you’ve made in the past. Also pay attention to broker fees; these can spiral out of control if you’re not careful.
- Understand the risks. Futures trading is a bit riskier than trading stocks since you’ll essentially be placing bets on how you think prices will change for a given asset in the near future. This can be problematic for commodities that are especially volatile since they could lead to heavy losses. You’ll also want to be careful buying on margin since you could face a margin call if your investment doesn’t pay off.
- Do your own research. Before any trade, do your research. Learn how the commodity or asset has fluctuated in price in the past, the factors that could influence its prices in the future, and what variables could get in the way of your original prediction. Don’t let a “hot tip” or a single article rule your decision-making.
- Avoid basing decisions on a hivemind. If you subscribe to any futures trading forums, or if you check the pulse of the general public, you’ll be tempted to base your decisions on the perceptions of the hivemind. For example, if everyone seems excited about a new tech company, you might bet that the price will increase. However, you’ll need to be wary that oftentimes, these hiveminds exaggerate reality or ignore key nuances in the complete understanding of an asset.
- Know when to exit. If your contract isn’t panning out the way you’d thought, it’s important to exit early, possibly with a stop loss order. New investors oftentimes try to hold on longer than is reasonable, and end up losing more money because of it.
- Focus on a discipline. Futures trading requires even more in-depth knowledge about a given industry (or commodity) than typical stock trading; since you’re preparing for a fixed date in the future, you’ll need to make predictions based on hundreds, if not thousands of variables. Accordingly, it’s a good idea to focus most of your attention on one or two key disciplines, so you can greatly improve your understanding of those industries and the variables surrounding them.
- Keep your portfolio balanced. Though it’s valuable to specialize in one or a few specific industries, you’ll also need to keep your portfolio sufficiently diversified to protect against risk. Trade multiple types of futures, and make sure you’re investing in other ways other than futures trading.
- Start slow. Every new investor is going to make mistakes and take losses when trading futures, especially in the early days of your career. Accordingly, it’s a good idea to start slow; trade low-valued contracts in areas in which you feel the most confident, and gradually scale up from the bottom.
Nobody can become a successful futures trader overnight, so don’t be surprised if you run into some hiccups as you navigate the learning curve of this unique investing strategy. Do everything you can to prepare for your trades, and learn from your mistakes as you gradually improve.