How to Trade Futures

CHAPTER

02

How to Trade Futures

Interested in learning how to trade futures and what they’re all about? Well you’ve come to the right place.

In this post we will outline everything you need to know to get started trading futures.

Set Realistic Trading Expectations

The internet is full of trading gurus running around town in their Ferrari’s and flying in their Private Jets trading from remote places…. Don’t buy into the hype!

I’ve been professionally day trading for over 15 years and the first thing I will tell you is it takes a ton of hard work paired with extreme focus and discipline to be successful in this business. Try to take shortcuts and you will only set yourself up for failure.

You need to set realistic expectations. Without them you will easily become discouraged and distracted decreasing your odds for success. Most new traders will experience bumps along the road.

Listen, I couldn’t picture myself in any other industry. I love day trading and will be a trader until I retire. You can do it, but it’s going to take hard work on your end.

A lot of new traders think they will be millionaires in a few weeks. So DON’T set these kinds of expectations or you will never reach your true goals. Continue to work hard and you will get where you want to be. (You’re putting in the effort right now 🙂 Nice work!)

Different Types of Trading

Before you begin trading, you need to decide what type of trader you’re going to be. Let’s look at the four categories of traders and the advantages and disadvantages of each.

Scalping

Scalping is the most short term type of trading. Scalpers will typically only have trades open for a few seconds or minutes at most, as they focus on targeting small intraday movements.

A scalper’s goal is to catch small profits multiple times throughout the day that eventually accumulate to nice profits due to the number of trades placed in a day.

Scalping requires the ability to think and act in an extremely fast paced environment.

Pros:
I began my career as a scalper at GPC using a Level II. I liked being a scalper as I never got bored during the day due to the number of trades I would place. I also feel my risk was reduced greatly due to the fact that I never held positions overnight.

Cons:
Scalping requires you to be in front of your charts 24/7 with extreme focus, which eventually can lead to burn out. Scalping also requires extremely tight spreads and commissions as they eat up a lot of your profits due to the number of trades you execute in a day.

Day Trading

Day traders are very similar to scalpers but trade less frequently and hold positions for minutes to hours yet still never overnight.

Day traders use fundamental and technical analysis, using technical indicators such as MACD (Moving Average Convergence Divergence), Cumulative Delta, NYSE Tick, etc… to help identify trends and make trading decisions.

Pros:
A little slower paced and less intense than scalping. Similar to scalping you don’t hold positions overnight helping to mitigate your overall exposure.

Cons:
Day trading still requires a time commitment which can be discouraging for new traders who have a lot of other commitments.

Ultimately, I’m primarily a day trader and wouldn’t have it any other way.

Swing Trading

Swing traders look to take fewer trades while capturing larger market moves by holding positions for several days up to a few weeks.

Pros:
Swing trading requires less of a time commitment than day trading or scalping.

Cons:
Typically as a swing trader your strategy is going to produce fewer setups due to the longer time frames you will be looking at. It can be a difficult style of trading for someone who is impatient as holding onto positions long term requires a lot of patience and strong nerves.

Finally, you will be exposed to more market risk than a day trader as you will be holding positions overnight.

Position Trading (Investing)

Position traders hold on to positions for several months and sometimes years. Typically trade decisions are based on macro variables such as a company’s financials, supply and demand of a market, etc…

Pros:
Position traders have the lowest time commitment of all traders as they are not concerned with micro fluctuations in price. However, you still will need to spend a few hours of analysis everyday.

Cons:
Most exposure to macro and micro news events.

Buying and Selling Futures

When trading a security you only have two options, go long or shot.

Traders put on long positions with the expectation that a securities price will rise in the future at which point they will be able to sell the security for a profit.

Traders put on short positions with the expectation that a securities price will decline in the future at which point they can buy back the security for a profit.

You may ask how can I sell a security I don’t own?

Ultimately, you’re borrowing the security from your broker to sell in the prediction that the price will go down at which point you can buy back the security at the cheaper price and return to your broker.

Just remember… Long = Buy & Short = Sell

If you’re “flat” you currently have no position.

Basics of a Futures Quote

All future quotes are quoted with two prices: the bid and the ask.

What is the “bid”?
The bid is the price at which someone is willing to buy a security.

What is the “ask”?
The ask is the price at which someone is willing to sell a security. The “ask” is also known as the “offer”.

What is the “spread”?
The spread is the difference between the bid and the ask.

Futures Quote

How Future Orders Get Executed

A common misconception among traders is that your trading platform is connected directly to the securities market. This is not the case.

When you place an order to buy or sell a futures contract on your trading platform your order is sent to your broker. Your broker then determines the best way for the trade to be executed. By law, your broker is obligated to give you the best possible order execution.

Brokers have several options on where they will route the order to be filled.

Exchange: For a security listed on an exchange your broker can send the order directly to the floor of the exchange. The downfall of this option is execution can be slow because the process is not automated and you’re dealing with humans.

Market Maker: A market maker is a firm whose purpose is to help provide liquidity to markets. They stand ready to buy or sell securities and often will pay your broker for routing orders to them.

Electronic Communication Network (ECN): Your broker may route your order to an ECN that automatically matches buy and sell orders at specified prices. Mostly used for limit orders.

Internalization: Your brokerage may have their own inventory of a given security of which they have the option to sell to you.

Most trade orders are executed within a blink of an eye no matter what option your brokerage decides to use to fulfill the order. However, your curious mind should not be satisfied on how orders are routed.

Order Types

Whether you decide to go long or short, there are two main order types you will use to enter into a trade.

Market Orders are used to instantly go long or short a security at the best price. With a market order, execution of the trade order is guaranteed but at what price is not.

When you “hit the bid” you’re sending a market order to sell at the best bid price.

When you “take the offer” you’re sending a market order to buy at the best ask price.

Limit Orders allow you to set the exact price that you will buy or sell a security but execution of the trader order is not guaranteed. It’s an order placed to either buy below or market or sell above the current market

There are 4 types of Limit Orders you will use.

Buy Limit: Order to buy a security at or below current market price.

Sell Limit: Order to sell a security at or above current market price.

Buy Limit and Sell Limit Orders

Buy Stop: Order to buy at a price above the current market price. Buy stops trigger a market order to go long when the market price touches the stop price.

Sell Stop: Order to sell at a price below the current market price. Sell stops trigger a market order to go short when the market price touches the stop price. 

Depth of Market

Futures Depth of Market

Depth of Market displays the inside market as well as all of the resting limit orders (not filled) on the bid and ask for a given security at every price point.

The Inside Market is the best bid price (highest price someone is willing to buy at) and the best offer price (lowest price someone is willing to sell at).

In the example above the Inside Market would be 3029.75 by 3030.00. If you wanted to buy instantly you would pay 3030.00 and if you wanted to sell instantly you would pay 3029.75.

Calculating Profit and Loss on Futures

To calculate your profit or loss on a futures trade use the following formula.

Profit = Number of Contracts X Price Per Tick X Number of Ticks

For our examples we’re going to use the e-Mini S&P 500 (ES). Here’s the contract specs.

Symbol: ES
Ticks Per Point: 4
Price Per Tick: $12.50

Example 1:
The ES (S&P500) is trading at 3020.25 x 3020.50. You place a market order to go long and are filled at 3020.50. You set a Sell Limit at 3024.50 as your Take Profit and a Sell Stop at 3019.25 for your Stop Loss. Price rallies and your take out on the offer at 3024.50.

What was your profit or loss?

Step 1 – (3024.50 – 3020.50) = 4 Points
Step 2 – 4 points x 4 Ticks Per Point = 16 Ticks
Profit = 16 x $12.50 = $200

Example 2:
The ES (S&P500) is trading at 3010.00 x 3010.25. You place a market order to go short and are filled at 3010.00. You set a Buy Limit at 3005.50 as your Take Profit and a Sell Stop at 3012.25 for your Stop Loss. Price rallies and you’re taken out on the offer at 3012.25

What was your profit or loss?

Step 1 – (3010.00 – 3012.25) = -2.25 Points
Step 2 – -2.25 points x 4 Ticks Per Point = -9 Ticks
Loss = -9 x $12.50 = -$112.50

Now that you have a solid grasp on how futures contracts are traded it’s time to pick a broker.

Choosing a Charting Platform

No matter what type of trader you are, you will want to spend time researching charting platforms.

Yes, every broker provides some sort of charting package but some are very basic and may lack specific indicators or tools for your trading style.

Most of the elite charting platforms are owned by third parties, not the brokerage. Some of them have the option to directly connect to your brokers data feed. If they don’t, you may be able to purchase a data feed outside of your brokerage.

For example, I use Sierra Charts for my charting platform. They do link directly to my brokers data feed but if they didn’t you can purchase third party data feeds directly from their site.

The only downfall if it’s not directly linked to your brokerage is that some features like trading directly from your charts won’t be enabled which really isn’t that big of a concern.

Finally, most charting companies offer a free demo. Check a few out before making your final decision.

Choosing a Futures Broker

There’s several main components you should evaluate when choosing a broker.

  1. Products: Some brokerages offer a variety of different securities while others specialize in a particular niche like Futures, Options, or Forex. The main point here is that you need to select a broker that offers the products you want to trade.
  2. Commissions: Every broker charges different fees. Commissions will affect scalpers and day traders more than swing and position traders simply due to the number of trades. Commissions add up fast so make sure your broker is competitive with the rest of the market.
  3. Margin Requirements: I don’t believe margin is that important due to the fact that you are probably over leveraging your account if you’re worried about it. However, it’s important to note different brokers offer different intraday margins. Intraday margins are the amount required in your account to put on a trade during regular market hours.
  4. Minimum Account Size: Every broker has a minimum initial deposit, some much more than others. I don’t believe you need a $25,000 account to begin trading, so definitely something to consider when choosing your brokerage.
  5. Training: If you’re a new trader you will want to make sure your broker offers ample training on their trading platform. I would suggest checking out a broker’s Youtube Channel to see what kind of training they offer. Some brokerages even bring in traders to discuss strategies and to teach traders on the fundamentals of trading.
  6. Customer Support: If you’re trading futures or any other security after hours you will want to make sure they have a 24 hour support desk.
  7. Charting Packages: Every broker offers some sort of charting package but they are not all created equal. A lot of the time the charting package you want will be based on your trading strategy.

Choose or Develop a Trading Strategy

We’re not throwing blind darts here are we? NO!

You need to have a detailed trading strategy that outlines exactly when you enter and exit the market.

One problem a lot of traders face is they think they can trade any strategy. Everyone’s personalities are different and some strategies will be better suited for certain personalities.

For example, although it’s something I’ve worked on tirelessly over the years to improve my trading, I’m very impatient. I know trading longer term strategies isn’t where I excel. My personality is better suited for a fast pace environment where my trades are typically no more than an hour.

You may not know what type of strategy is best for you when you first begin trading but you should Sim test several. Most trading strategies can be tweaked some to better fit your personality.

Having a tough time sitting in trades for hours? Try your strategy on a shorter time frame.

Having a tough time pulling the trigger on trades? Sounds like you’re more analytical than some. Try your strategy on a longer time frame.

Back Test & SIM Trade Your Strategy

I’m about to give you the ULTIMATE FORMULA FOR TRADING SUCCESS. Ready?

  1. Back test your strategy for a minimum of 50 trades under different market conditions including high and low volatility days and trending versus range bound days.
  2. Sim trade your strategy for a minimum of 100 trades. When I began at GPC I was on a simulated account for more than two months prior to placing a trade.
  3. Write a trading plan that outlines all of your rules including your strategy as specifically as you possibly can. FOLLOW YOUR PLAN!
  4. Once you’ve proven you’re able to be consistently profitable on a Sim account, start trading on a small live account. Trade the minimum contract size you can until you’ve proven you can be profitable for 30 days. Then slowly overtime start increasing your trade size as your account grows.

Trading is one of the few industries where you can test your strategy in a live market without risking any money. TAKE ADVANTAGE OF THIS!

One of the main problems I see with new traders is they become impatient and start trading on a live account way too fast.

When you first start out, you’re going to make mistakes. Why not get through all those mistakes prior to trading real money?

The problem with traders jumping into a live account too fast is that they can destroy their psyche prior to even knowing what they’re doing. Once this happens, you may be done trading prior to even truly getting started.

Write a Trading Plan

Your trading plan is the “Holy Grail” of trading. At this point you should already know you have a trading strategy that gives you an edge and that you can successfully trade it on a sim account. Layout the exact rules you used to successfully sim trade your strategy in your trading plan.

No matter how great of a trader you are you will experience drawdowns. It’s part of the business. Your trading plan is what you fall back on during these times to pull out of a drawdown.

You should review your trading plan everyday and update it at least once a month. It should be a living document that will change over time as you grow as a trader.

Going Live

Well it’s time! You’re ready to start trading live…Well maybe not quite actually yet but now you have a detailed process to follow.

The best advice I can give you is when going live follow your trading plan to a “T” and start trading as small as you can. As you see signs of progression and your account balance grows SLOWLY increase your trading size.

Conclusion

After reading these first two chapters you should have a clear understanding of how to trade futures and have a path to follow to get started trading futures.

Remember, don’t buy into all the hype you see online about making tons of money as a trader and that it’s super easy. In reality it’s extremely hard work.

Be patient with your growth as a trader and constantly be evaluating yourself and trying to improve. This game is a marathon, not a sprint.

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CHAPTER

05

Futures Trading Strategies

Coming Soon

CHAPTER

06

Trading Plan

Coming Soon

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