Futures Trading Strategies Every Trader Should Know

Futures trading can be an effective way to diversify your portfolio and capitalize on financial market moves, but it requires an understanding of trading strategies to be successful. This comprehensive guide will walk you through the most important futures trading strategies every trader should know.

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Key Takeaways:

Futures contracts allow traders to speculate on commodity and financial markets.
Popular futures trading strategies include trend following, breakouts, pullbacks and spreads.
Create a detailed trading plan matching your personality and risk appetite.
Use proper risk management and keep developing your skills.

With the right preparation and discipline, implementing these futures trading strategies could lead to long-term trading success.

What Are Futures Contracts?

Futures contracts are legally binding agreements to buy or sell a commodity or financial instrument at a predetermined price at a specified time in the future. The underlying assets can be commodities like crude oil, corn, or gold, as well as financial instruments like stock indexes and treasury bonds.

When a futures contract is made, the buyer agrees to pay the seller the agreed upon price at expiration even if the market price ends up being higher. The seller agrees to provide the asset at expiration even if the price drops. This helps producers and consumers hedge against price volatility.

Futures trade on exchanges like the Chicago Mercantile Exchange (CME) and are standardized in terms of quantity and quality to facilitate trading. They typically have quarterly expiration cycles.

Why Trade Futures?

There are several advantages to trading futures contracts:

Leverage – Futures require less capital upfront than the equivalent underlying asset. This allows traders to profit from larger position sizes.
Risk Management – Futures can be used to hedge portfolio risk and protect against unfavorable price moves.
Speculation – Traders can profit from correctly anticipating the direction of the market.
Diversification – Futures provide exposure to commodities, currencies, and global markets.
High Liquidity – Large trading volume makes entering and exiting trades fast and efficient.

Futures Trading Strategies

Now that we’ve covered the basics, let’s explore some of the most common futures trading strategies used by professional traders:

1. Trend Following

Trend following aims to capitalize on the continuation of price trends. Traders identify the overall directional bias of the market to determine whether to go long or short. The goal is to hold the position as price continues trending higher or lower.

Tips for trend following:

Use indicators like moving averages to identify the trend. The 50 and 200-day moving averages are commonly used.
Go long when price is above the moving average and short when below.
Use higher time frames like the daily or weekly charts to identify the major trend direction.
Determine exit points based on break of trend lines or reversal candlestick patterns.

2. Breakout Trading

Breakout trading aims to enter into a trade when price breaks out of a period of consolidation. The breakout signals the start of a new trend, providing an opportunity to capitalize early on the price move.

Steps for trading breakouts:

Identify support and resistance levels where price has consolidated. This can form trading ranges or chart patterns.
Place entry orders just above resistance for a buy trade or below support for a short trade.
Set a stop loss below the recent swing low for longs or above the swing high for shorts.
Target taking profits once price has broken out and extended the move.

3. Pullbacks

Pullbacks involve entering into trends after brief retracements against the prevailing trend. This provides an opportunity to get in with a better risk reward ratio compared to chasing price.

Trading rules for pullbacks:

Identify an existing trend using a moving average crossover or chart pattern breakout.
Wait for price to retrace and test the broken trendline, support or resistance level.
Enter long on the pullback down in an uptrend or short the pullback up in a downtrend.
Place stop loss above the recent swing high on short trades or below swing low for longs.

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4. Spread Trading

Spread trading involves taking a directional position between two correlated futures contracts. Traders will go long one futures contract and short another related contract.

Benefits of spread trading:

Hedge against market risk by taking both sides of a trade.
Potentially profit whether the market moves up, down or sideways.
Requires less margin than outright futures positions.

Spreads can be done with crude oil and gasoline, gold and silver, or S&P 500 and Nasdaq futures for example.

5. Scalping

Scalping aims to profit from small price changes using high leverage. Scalpers open and close trades within seconds or minutes to capture quick moves.

How to scalp futures:

Use a high volume futures product like the E-mini S&P 500.
Execute trades using market or limit orders during volatile periods.
Use wider stops to allow price movement as part of strategy.
Close trades quickly once profit target is reached.

This requires fast trade execution and high focus as holding periods are extremely short.

Developing a Futures Trading Plan

A trading plan is essential for applying these futures strategies successfully and consistently:

Trading Style – Match strategy to your personality and risk tolerance. Trend following suits patient traders, scalping needs discipline.
Contract Selection – Stick to just a few futures products with liquidity and volatility. Know seasonality and fundamentals.
Entry Rules – Standardize rules for trade entry, stop loss and take profit. Follow them precisely.
Risk Management – Limit risk to a small percentage of account size on each trade. Use stops.
Record Keeping – Track performance to identify strengths and areas for improvement. Review regularly.
Continuous Learning – Read books, take courses and keep developing your trading skills. Stay up to date on markets.

Frequently Asked Questions

Q: What are some common futures trading strategies?

A: Some common futures strategies include day trading, spread trading, hedge strategies, and pullback strategies.

Q: How can I start day trading futures?

A: To start day trading futures, you need to open an account with a futures broker and have a sufficient amount of capital to meet the margin requirements.

Q: What is a short position in futures trading?

A: A short position in futures trading is when a trader sells futures contracts with the expectation that the price will go down, allowing them to buy back the contracts at a lower price and make a profit.

Q: What is a long position in futures trading?

A: A long position in futures trading is when a trader buys futures contracts with the expectation that the price will go up, allowing them to sell the contracts at a higher price and make a profit.

Q: What is a futures broker?

A: A futures broker is a licensed professional who facilitates the buying and selling of futures contracts on behalf of traders.

Q: How do interest rates affect futures trading?

A: Changes in interest rates can impact the pricing and trading of futures contracts, particularly those tied to interest rate instruments such as treasury bonds or notes.

Q: What is the CME Group?

A: The CME Group is the world’s leading and most diverse derivatives marketplace, offering futures and options contracts across a wide range of asset classes.

Q: What is a calendar spread in futures trading?

A: A calendar spread in futures trading involves buying and selling futures contracts of the same underlying asset with different expiration dates.

Q: What are some basic futures trading strategies?

A: Some basic futures trading strategies include trend-following strategies, breakout strategies, and mean-reversion strategies.

Q: How do pending orders work in futures trading?

A: Pending orders allow futures traders to set specific price levels at which they want to enter or exit a trade, and the order is automatically executed when the market reaches that price.

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In Summary

Futures trading provides opportunities but also carries risk. Use stop losses, adequate position sizing and risk management. Develop your skills with a practice trading account first. Keep refining your strategy until you are consistently profitable.

Remember, there is no holy grail futures trading strategy. Success comes from understanding market dynamics, practicing solid trading principles and developing the discipline to follow your plan.