What are the futures trading strategies?


What are the futures trading strategies?

Learn the basics of futures trading and futures trading strategies for getting started in the futures markets. We start with what futures contracts are, looking at the best futures trading strategies, their pros and cons, and associated risks.

What are future contracts?

A future is a contract concluded between two parties (buyer-seller). These agree to buy/sell an underlying at a predetermined time and price. It is essential to outline that these contracts are standardized and traded on stock markets. 

With these two characteristics, a future is an essential product for investors, companies, and commodity producers. A forward contract is similar to a futures contract, but no stock broker is involved, and the buyer and seller can agree on all elements of the contract.

The underlying value and the quantity of a future are fixed. In other words, this contract is standardized. These can be agricultural products and financial instruments such as the US dollar. Since this contract is standardized, the only variable in the Future is the price. The interaction between supply and demand in the stock market determines this price. One of the most popular futures for trading is Mini S&P 500 futures.

Futures trading plan

Futures trading plans usually consist of the following: 

Going long – means buying futures and profiting from price increases.
Going short or selling when the price decreases.
Buying and selling two contracts and profiting from widening or narrowing the price difference. This is spread trading. You can trade on the same underlying asset but with different expiration dates. Or you can trade closely related assets like gasoline and crude oil.

There are numerous opportunities for profits that the futures market offers. But to generate great success, you need to use tested futures trading strategies. Here is an overview of the best futures trading strategies.

Best Futures Trading Strategies

The Pullback Strategy
Breakout Trading
Going Long
Spread Trading

The Pullback Futures Trading Strategy

This strategy focuses on price pullbacks. The pullback occurs when the price breaks a support line (or crosses a resistance line upwards) and then returns to this line, which has become a resistance line (or support line). We find the pullback on the main reversal patterns of the graphical analysis, which reinforces the reliability. The resistance line represents the level where the price struggles to break above. The support line represents the point at which the price struggles to break below.

The pullback is a significant change in the trend of an asset, highly sought after by traders who can, depending on the factors explaining this fall in prices, position themselves upwards or downwards on the asset, directly or via a derivative product. , with or without leverage.

Once you spot an uptrend, it means the price goes above the resistance line and reverses the resistance level. After the reverse, you may go with the long position following the underlying uptrend direction.

In case of a downtrend, the price is below the support level, reversing and returning to the support line. Here we have a pullback, so you can go with the short position following the underlying downtrend direction.

Pullbacks occur when traders are making profits, and the futures prices are pushed in the direction opposite of the initial breakout.

If you miss the original price movement, you need to wait so that the price gets back to the support and resistance levels to open a trade at a more favorable price. 

Breakout Futures Trading Strategy

The breakout strategy is a popular day trading method applicable to many assets. It is convenient to apply it in futures contracts trading when the price passes a certain trading range. The aim is to seize the volatility of the market while the price breaks out of the support/resistance line. The breakout is followed by an increased trading volume. In that case, you need to spot narrow trading channels with lower volatility.

After a breakout, the market goes through greater volatility. It’s due to pending orders, so you may benefit from this situation if you take a position in the breakout’s direction. In general, you should go short once prices go below a support level. You can go long once the asset’s price goes above the resistance point.

Going Long Trading Strategy

Future traders can purchase future contracts while expecting the underlying asset’s price goes up over a specific time frame. If your prediction of the timing and price direction is precise, you can postpone selling for a higher price. If the price of the underlying decreases, you are doomed to loss. Your gain or loss can be higher than the margin deposit due to the leverage effect.

Spread Futures Trading Strategy

This strategy consists of selling one futures contract and purchasing another one at a different time. The objective is to benefit from an unexpected relationship change between the selling price of one contract and buying price of another contract. This futures trading strategy lowers trading risks since the spread represents the hedge. Playing on the difference between two contracts leads to lower risks. This strategy doesn’t depend on market volatility.

Risk management

Price limits are one example of a loss protection mechanism.

Price limits are the maximum fluctuations allowed by the stock exchange per session. These differ from one Future to another and are usually expressed in points (ticks) in the world of Futures. Different actions are triggered when these limits are crossed depending on the product concerned. For example, quotations can be suspended and resumed in the following session.

The importance of margin in futures trading strategies

One of the most important principles of futures trading is margin. Regardless of the underlying value, a margin is always required to trade in Futures. The margin size is determined by the stock market. Sometimes, the broker may increase the margin amount as part of their risk policy. Margin call is an important part of futures trading.

Initial margin

The initial margin is a kind of guarantee that the buyer or the seller must have on his account to trade a Future. If the capital available in the account is less than the required initial margin, then the buyer or seller will not be able to trade this Future.

It’s important to remember that the initial margin may change due to increased market volatility. Think, for example, of the CME (Chicago Mercantile Exchange), which had increased the margin for Natural Gas Futures (NG) due to very high volatility. Within two weeks, the price soared 50%. Such an increase can result in extremely risky situations due to the leverage effect of the Future.

Maintenance margin

This is the margin needed to hold a position. In other words, this corresponds to the minimum amount that must appear in the account in order to be able to hold a Future. This requirement applies to both long and short positions. This margin is less than the initial margin. It is also the exchange that offers the Future that determines its size. Just like the initial margin, the broker can choose to apply a higher maintenance margin than that determined by the exchange.

When the account balance falls below the maintenance margin, then the broker makes a margin call. In this case, the investor has the possibility to pay additional funds to go above the amount of the maintenance margin. However, if the funds do not arrive in the account on time, the broker may close the position. In financial jargon, this operation is called “position liquidation.”

Futures trading strategies – Summary

Futures are complex instruments for trading. Thus you need to understand all the ins and outs before you start trading these contracts. The main perks are using leverage on various financial contracts with cost-effective hedging strategies. However, beware that futures trading can result in overleveraging, and it can be tricky to juggle expiration dates if you trade multiple futures contracts. Also, if you don’t roll off your positions or don’t close them on time, you will have to accept the underlying asset’s physical delivery.

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