What is Futures Trading? Simply Explained Beginners Guide

This is mitigated for futures by the exchange clearinghouse, which guarantees the contract. While each side is taking a risk that the price they pay now is close to the actual price at the settlement month, each party insures against the risk of a wide swing against them in oil prices. One more benefit to futures trading is tax compared to stocks, where the total of 100% of profits are taxed as ordinary income, and futures provide a potential tax benefit. These two types of contracts are either for physical delivery for hedgers or cash settlement for speculators when contracts are closed out or netted.

Stock futures investing lets you trade futures of individual companies and shares of ETFs. Trend followers track prevailing market trends by purchasing during price uptrends and selling during downtrends. This approach relies on indicators like moving averages, moving average crossovers (such as a “Golden Cross”), and trendlines to determine when to enter and exit positions. To start trading futures on our award-winning trading platform,4 you can create a live account with us.

1. Physical delivery is standard for commodities like oil, gold, or wheat.
2. Investors risk losing more than the initial margin amount because of the leverage used in futures.
3. Commodities represent a big part of the futures-trading world, but it’s not all about hogs, corn and soybeans.
4. Investors, fund managers, and financial institutions use bond futures to protect their portfolios against interest rate changes or to take positions based on their interest rate outlook.

Add futures to your account

Futures markets, especially those dealing with popular commodities and financial instruments, have high liquidity levels. Liquidity allows traders to quickly enter and exit positions without suffering slippage or poor fills. Most futures contracts are closed out or rolled over before the delivery date, with only a small percentage—typically less than 2%—resulting in physical delivery. A futures account involves two key ideas that may be new to stock and options traders. One is “initial margin,” which is not the same as margin in stock trading. Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

Futures trading is facilitated by futures exchanges, like the Chicago Mercantile Exchange (CME), and requires investors to have an approved brokerage account. When traders or companies enter a futures contract, it obliges them to sell or buy the underlying assets at a set price and date in the future. You can trade listed futures on our US options and futures platform, which gives you access to indices, forex, interest rates, commodities, stocks and exchange-traded funds (ETFs).

Understanding Futures Contracts

They invest large sums of money in financial instruments, including futures contracts, on behalf of their stakeholders or beneficiaries. In the futures market, institutional investors may engage in hedging to protect their portfolios from adverse market moves or speculate on future price directions to enhance returns. Given the large volume of assets under management, institutional investors can significantly affect market prices through their trading activities. Hedgers use futures contracts to mitigate the risk of price changes going too low when the time comes for them to sell an asset or increasing too much if they have to buy it later in the spot market.

Decide whether to go long or short

Below, we guide you through the kinds of futures, who trades them, and why, all while showing that you don’t need to get on horseback to beat news of a grain-filled ship arriving to gain from these investments. For millennia, forward contracts have been employed to lock in future prices for financial stability no matter what happened to the harvest that year. But many have also used them to speculate and profit from changing prices in the market. Whereas with other investing strategies, margin requirements for long and short positions differ, with futures contracts, the margin is the same for both without additional requirements. If the prices fall, the trader can offset the transaction, which means closing a transaction to realize the profits before the contract expires. For example, the initial margin of one wheat futures contract is $2,500, which is a required minimum to open a trade on a futures exchange.

Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. Futures statements are generated both monthly and daily when there is activity in your account. Find out more about a range of markets and test yourself with IG Academy’s online courses.

He holds a Bachelor’s Degree in English Literature from San Francisco State University, and conducts research on forex and the financial services industry while assisting in the production of content. High levels of leverage can introduce catastrophic risk if a trade goes in the wrong direction. Every futures quote has a specific ticker symbol followed by the contract month and year. Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.

If the price goes up to $7 a bushel, the farmers get less than they would have otherwise, but the cereal producer makes out. All strategies have ups and downs, but you should decide which one you want to go with and define it for your futures trading. Share dealing and IG Smart Portfolio accounts provided by IG Trading and Investments Ltd, CFD accounts and US options and futures accounts are provided by IG Markets Ltd, spread betting provided by IG Index Ltd. Investors should have a basic if not thorough understanding of how futures trading works before they begin. Knowing the benefits and drawbacks can spell the difference between success and loss. Profitable futures are taxed on a 60/40 basis, meaning that only 40% of profits are taxed with the standard income tax rate, and the rest, 60%, is taxed as long-term capital gains.

Hedging with futures enables you to control your exposure to risk in an underlying market. For example, if you own shares in companies on the FTSE 100 and you’re concerned about them dropping in value, you could short a FTSE 100 index future. Your potential profits from the trade could offset a proportion of your share position losses. Futures are derivative contracts that let you speculate on the future price of some asset or commodity, or to let you hedge against existing positions.

Companies can plan their budgets and protect potential profits against adverse price changes. Investors risk losing more than the initial margin amount because of the leverage used in futures. Investors can also take a short speculative position if they predict the price will fall. If the price declines, the trader will take an offsetting position to close the contract. An investor gains if the underlying asset’s price is below the contract price and loses if the current price is above the contract price.

Joey Shadeck is the Content Strategist and Research Analyst for StockBrokers.com. He holds what is a supply doc dual degrees in Finance and Marketing from Oakland University, and has been an active trader and investor for close to 10 years. An industry veteran, Joey obtains and verifies data, conducts research, and analyzes and validates our content.