Futures Trading Systems

Written by Jacey Harmon
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Before we delve into the various futures trading systems that traders use, first I want to discuss the basics of the futures markets. Without going into too much detail about the history of futures markets, just know that futures, in one form or another, have been around since the 10th century. Over time, the market has become a lot more sophisticated and very efficient. The futures markets will play a direct role in what we pay at the gas pump, grocery store, and even Starbucks.

A futures contract is an obligation to buy or sell a specific commodity, on a pre-determined date, for a price that is agreed upon today. A futures contract guarantees that an exchange will happen at some point in the future, hence the name: futures. Unlike options, which are rights to buy or sell at some time in the future, a futures contract is an actual contract. You agree to buy or deliver the specified commodity on the specified date of expiration. To release yourself from this obligation, you simply place a counterbalancing trade. Bought if you have sold, sold if you have bought.

There are three groups of futures contracts: commodity, financial, and index. Commodity futures deal with commodities: corn, oil, coffee, and livestock to name a few. Financial futures are those that are associated with currencies or interest rates. Index futures are tied to stock and commodity indexes. In the case of financial and index futures, the commodity to be delivered on expiration is cash.

Understanding Futures Quotes

To make matters more confusing for a novice futures trader, futures contracts will have different valuation methods. For example the e-mini S&P 500 futures contract is valued by multiplying the value of the index by $50. If the S&P 500 is trading at 1100 than the S&P 500 futures contract is worth $55,000. Meanwhile a contract for crude oil is valued by multiplying the specifics of the contract, 1000 barrels to be delivered, by the price of one barrel. If a barrel of crude is selling for $30, than a 1000 barrel contract would be valued at $30,000. The various futures exchanges will have each contract's specifications easily accessible to traders.

Knowing the specifications of a contract is integral to understanding how it is quoted. Without knowing the specs of each contract, understanding the quotes is pretty much impossible. The specs will clearly state the minimum price change for each contract. A rule of thumb is commodities are typically quoted per bushel, barrel, or pound. Index futures are quoted against the value of the tracked index. There is no rule of thumb for financial futures contracts, reading the specifications are very important if you are going to trade these types of contracts.

Futures Trading and Trading Systems

There are two types of futures traders in the market: speculators and hedgers. Hedgers are simply those who use the futures markets to eliminate risk from fluctuating commodity prices. Speculators are in the futures market solely to make a profit. The majority of people associated with futures markets are speculators. An overwhelming majority of trading systems are tailored to speculators.

Trading systems will revolve around having "long" or "short" positions. Essentially, if you think the contract's value will rise, you want to be long. If you think the value of the contract will fall, you will want to be short. In some form or another, all futures trading strategies work around long and short positions. The intended purpose of a trading system is to reduce the risk involved with futures trading. Futures are one of the most risky forms of trading instruments available. The large value of each contract and high leverage capabilities make for a dangerous combination to inexperienced and experienced traders alike.

Technical analysis is a fundamental aspect of a majority of trading systems. Technical analysis is simply the analysis of market prices for specific contracts. The basic theory behind technical analysis is that a trader can identify trends and possible changes in the market's direction by analyzing the price and volume of a contract. Spreads are another popular component of trading systems. A spread is when you buy a near contract and sell the far contract. For example, you would buy a March Corn contract and sell a May Corn contract. This type of strategy is very popular as it will limit risk, but it will limit potential gain as well. When choosing a trading strategy, focus on finding a strategy that matches your risk tolerance, time frame, and experience.


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