Beginner’s Guide to Day Trading Futures

Want to learn how to trade futures and the basics of future contracts? Well you’ve come to the right place.

The following futures guide is full of insights and strategies for traders looking to hone their current skills and get up to speed on the latest trends in futures trading. Let’s get into it!

What is a Futures Contract

A futures contract is a legal agreement through an organized exchange to buy or sell a particular asset or commodity at a predetermined price but delivered and paid for on a future date.

Futures trading is simply the exchange between buyers and seller of these contracts.

New traders hear this definition and get scared/confused about “paid for on a future date”. I promise that there’s very little difference between day trading a futures contract versus stocks.

History of Futures Contracts

Future contracts have been around for a VERY long time. They can be traced all the way back to 1750 BCE in Mesopotamia, located in present-day Iraq!

Similar contracts can be found mentioned in the Hammurabi Code (above), one of the oldest deciphered writings in the world found in Babylonian legal text composed 1755–1750 BC.

The need for futures contracts arose anytime two parties needed to exchange a good or asset for an agreed-upon price at a future date. In order to protect both parties in the transaction there needed to be a written contract. Thus, future contracts were born.

The first official futures exchange in the United State was the Chicago Board of Trade (CBOT) which opened in 1848.  The first futures contracts traded were corn, wheat, and soybeans. 

Who Trades Futures

Future traders can be categorized into two groups, hedgers and speculators.

Hedgers use the futures market to manage price risk of a given product.

In our example from earlier, both the airline company and the oil producer were hedging against any large moves on the price of oil, thus both would be considered hedgers.

Speculators are traders who accept the price risk in an attempt to profit from favorable price movement.

Speculators provide the majority of liquidity in the futures markets. As a result this allows hedgers to enter and exit the markets in a more efficient manner.

Speculators are made up of full time professional traders, small individual traders trading their own funds (like yourself), portfolio managers, and hedge funds.

Using Futures to Hedge Risk

To illustrate the real purpose of the futures market, consider the airline industry and the cost of jet fuel.

Southwest Airlines wants to lock in jet fuel prices to avoid an unexpected increase in oil prices (Hedger). Future contracts give Southwest the ability to lock in fuel prices for delivery at a future specified date.

Just like Southwest, a fuel producer may find it beneficial to hedge against the decline in the price of oil allowing them to ensure they can remain profitable if oil prices were to drop.

The producer sells a futures contract to ensure protection against an unexpected decline in prices.

Both sides agree on specific terms: To buy (or sell) 10 million gallons of fuel, delivering it in 90 days, at a price of $40 per gallon.

Southwest Airlines did this in the early 2000’s, making them one of few airlines to remain profitable as oil prices soared.

Basics of Futures Trading

Trading futures isn’t much different than any other security, you simply need to understand a few of the basics. Let’s start by looking at the fundamentals of a futures contract.

Contract Size – Every futures contract has a predetermined size that does not change. For example, the E-mini S&P 500 futures contract size is always $50 times the price of the index. Specifications for all futures contracts traded at the Chicago Mercantile Exchange (CME) can be found at https://www.cmegroup.com/

Contract Value – The contract value of a futures contract can be determined by multiplying the contract size by the current price of the derivative. For example, the E-mini S&P 500 has a contract size of $50. If the current price of the ES (E-mini S&P 500) is $2,905.00 then the contract value is $50 times $2,905.00 which equals $145,250.

Tick Size – The minimum price movement of a futures contract is measured in ticks. For you Forex traders a tick is similar to a pip. Tick size will vary from contract to contract. 

A tick on the ES (E-mini S&P 500) is equal to one-quarter of an index point. Since an index point is worth $50 on the ES, one tick is equivalent to $12.50.

Types of Future Contracts

The futures market has expanded greatly since the traditional agricultural commodities began trading on the floor.

Now traders have access to multiple markets including:

• Agricultural Futures: Originally began at the Chicago Mercantile Exchange (CME). Includes grain, fibers, lumber, milk, coffee, sugar and even livestock
• Energy Futures: Includes common fuels such as crude and natural gas.
• Metal Futures: Industrial metals, such as gold, steel, and copper.
• Currency Futures: Provide exposure to changes in the exchange rates and interest rates of national currencies
• Financial Futures: Vix Futures, Index Futures, and Treasure Futures

For the purpose of this guide, we will focus on Index Futures, as it’s where I believe anyone new to trading futures should begin.

Stock Index Futures

The four primary Index Futures day traders focus on are the E-mini S&P 500, E-mini Nasdaq 100, E-mini Dow, and E-mini Russel 2000. Let’s do a quick overview of each contract.

E-mini S&P 500
Symbol: ES 
Expiration: Trading terminates at 9:30 a.m. ET on the 3rd Friday of the contract month. Contract months are March (H), June (M), September (U), and December (Z) 
Exchange: Chicago Mercantile Exchange (CME) 
Tick size/Minimum Price Fluctuation: 0.25 points 
Tick Value: $12.50 
Ticks Per Point: Four, making each point worth $50 per contract

The E-mini S&P 500 (ES) is one fifth the size of standard S&P futures. Composed of 500 individual stocks representing the largest companies, the S&P 500 Index is a leading indicator of large-cap U.S. equities.

E-mini Nasdaq 100
Symbol: NQ 
Expiration: Trading terminates at 9:30 a.m. ET on the 3rd Friday of the contract month. Contract months are March (H), June (M), September (U), and December (Z) 
Exchange: Chicago Mercantile Exchange (CME) 
Tick size/Minimum Price Fluctuation: 0.25 points 
Tick Value: $5.00
Ticks Per Point: Four, making each point worth $20 per contract

Though I primarily trade the S&P 500 due to liquidity, the NQ is my next favorite futures contract. Every contract has different characteristics. The NQ tends to be more volatile due to the nature of tech stocks and can feel more volatile due to the pricing structure of the contract itself.

E-mini Dow
Symbol: YM 
Expiration: Trading terminates at 9:30 a.m. ET on the 3rd Friday of the contract month. Contract months are March (H), June (M), September (U), and December (Z) 
Exchange: Chicago Mercantile Exchange (CME) 
Tick size/Minimum Price Fluctuation: 0.10 points 
Tick Value: $5.00 
Ticks Per Point: 1, making each point worth $5 per contract

The E-mini dow is probably the index I trade the least. Again, every index has its own characteristics in terms of how it moves and I prefer the S&P 500 over the Dow E-mini. I primarily watch the Dow when looking at a macro picture of the market.

E-mini Russell 2000
Symbol: RTY 
Expiration: Trading terminates at 9:30 a.m. ET on the 3rd Friday of the contract month. Contract months are March (H), June (M), September (U), and December (Z) 
Exchange: Chicago Mercantile Exchange (CME) 
Tick size/Minimum Price Fluctuation: 0.10 points 
Tick Value: $5.00 
Ticks Per Point: 10, making each point worth $50 per contract

The Russell index measures the performance of two thousand of the smallest-cap US companies which features the top American stocks by market cap. 

I still prefer the S&P 500 but over the years I have traded the Russell due to volatility. I’m always looking for a balance of the most active markets paired with liquidity.

Settlement of Future Contracts

Whenever a speculator or a hedger decides to go long or short a futures contract they can settle a contract in three different ways.

Closeout: Closeout is the settlement method day traders will use. With this method you will close out any positions prior to contract expiry and your account will be marked for your realized profit or loss.

Physical Delivery: If a trader keeps a position open and allows it to expire then the contract will be settled by physical delivery or cash settlement. This will depend on contract specifications.

Instruments like index futures obviously settle by cash settlement as you’re not going to take delivery of index futures.

Oil futures are an example where the hedger will take physical delivery of the product for use. (Similar to Southwest Airlines discussed earlier)

Cash Settlement: Cash settlement does not require delivery. Instead the trader leaves the trade on and lets it expire and the transaction is completed by settling in cash.

As a day trader you won’t be using physical delivery or cash settlement as your settlement option. You will always close out of your positions prior to the expiry date and start trading the new contract.

Futures Margin Requirements

Futures are traded on margin. This simply means you pay a fraction of the total value of a given contract and borrow the remainder from your broker, allowing you to control a larger asset with less capital.

There’s two types of margin, initial margin and maintenance margin.

Initial margin is the amount of funds required by an exchange to initiate a futures position. 

Maintenance margin is the minimum amount that must be maintained at any given time in your account while you are in a position.

If your account balance drops below the maintenance margin level, a few things can happen: 

• You may receive a margin call where you will be required to add more funds immediately to bring the account back up to the initial margin level.
• Margin Call: Your broker may allow you to reduce your position in accordance with the funds remaining in your account.
• Liquidation: Your position may be liquidated automatically by your broker once it drops below the maintenance margin level.

Initial margin requirements are adjusted at times based on market volatility. As volatility increases so will the initial margin requirement.

Most brokers intraday margin is lower than the exchanges initial margin, you will have to check with your broker.

Now that you are familiar with some of the different contract types, let’s take a look at the process of actually buying and selling futures.

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.

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. 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 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 (DOM)

The Depth of Market, commonly referred to as DOM, 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).

Calculating Profit and Loss On Futures Trades

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.

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 order at 3024.50 as your take profit and set a sell stop at 3019.25 as your stop loss. Price rallies and you’re taken 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

Benefits of Trading Futures

When evaluating which market to trade you need to look at several primary factors including liquidity, news risk, volatility, tax, and any PDT rules if they exist.

Liquidity

The liquidity of a security determines the ease at which you can enter and exit a security without affecting that securities price. 

When trading less liquid securities there becomes a point where you begin to manipulate price when you enter or exit a trade.

For example, penny stocks tend to be very illiquid and if you have to exit a large position you could drastically influence the price.

When you trade a large position on an illiquid security it it becomes impossible to calculate your Reward to Risk because you can’t determine with any accuracy where you will be able to exit the position.

The liquidity of a security is becomes very important as you trading size progresses.

News Risk

News risk impacts some markets more than others, but stocks are especially susceptible to news risk. Ever been long or short a stock and the stock gets halted?

A stock halt can occur at any time, typically for a breaking news release, and it leaves traders helpless as they are not able to exit their trades until the halt is lifted and the stock is reopened.

I’ve seen traders caught on the wrong side of trade halts and wipe out everything they made over the last year or more in seconds. I personally lost over six figures on GOOG during earnings.

I had a sizable position on well in the money and there was an erroneous BTrade order placed that took Google from $500 down to 2$ in about 10 seconds.

Unfortunately my exit was within 10% of the price Google was trading at prior to the erroneous order so my trade wasn’t busted and I ate the significant loss.

Obviously you have news risk in any market you’re going to trade. However, index futures are going to be less exposed to micro news events.

Volatility

Volatility is simply how much the price of a given security fluctuates throughout the day. The larger the range, the higher volatility.

When volatility is low and prices are range bound, most day traders tend to get chopped up and find it difficult to make money.

I personally trade securities with higher volatility. It really depends on your trading style as some systems perform better in less volatile markets.

Volatility is important for traders to pay attention to as it does change over time.

You can see on the above chart of gold that prices were much more volatile from 2005 – 2012 when compared to 2000 – 2004 and 2012 – 2019.

Taxes on Futures

A huge benefit of trading futures contracts for U.S. traders is the tax advantages. What ultimately matters at the end of the day is what you take home, not you’re gross P&L.

NOTE: JumpstartTrading.com and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Profits on futures contracts are taxed at 60% the more favorable long term gains and 40% as ordinary income. 

Let’s assume you’re in the highest tax bracket of 37% currently. Obviously not all of your income is taxed at 37% but for illustration purposes we will assume all the profit in this example is taxed at 37%.

Payable Tax on Stock Vs. Futures

Stock Profit: $100,000
Tax Rate 37%
Taxes: $37,000
Futures Profit: $100,000

60% Taxed at the Long Term Gains Rate of 20%: $60,000 x .20 = $12,000

40% Taxed at the Ordinary Income Rate of 37%: $40,000 x .37 = $14,800

Tax Savings of Trading Futures over Stocks: $37,000 – (12,000 + $14,800) = $10,200

Depending on your tax bracket, the blended rate ends up being between 28% and 30%. Up to almost a 10% SAVINGS!

The tax advantages alone makes trading futures very attractive.

Futures Pattern Day Trading Rule (PDT Rules)

A futures trader does not fall under the Pattern Day Trading rules.

“FINRA rules define a pattern day trader as any customer who executes four or more “day trades” within five business days, provided that the number of day trades represents more than six percent of the customer’s total trades in the margin account for that same five business day period. Reference: https://www.sec.gov/files/daytrading.pdf

Currently, if you’re labeled a Pattern Day Trader you have to maintain a minimum account balance of $25,000 at all times.

The FINRA rule does not apply to trading futures. However, please realize that FINRA has the PTD rule not to limit people from making money but to protect them from losing money.

With smaller margin requirements and no PTD rule, traders will typically expose themselves to more risk than they should. 

I don’t believe it’s necessary for someone to have $25,000 in a trading account to start trading. Today’s retail market has plenty of options for traders with smaller account sizes including the newly released Micro Futures.

Conclusion

It was almost a decade into my career before I the majority of my day trading was done in the futures markets.

I wouldn’t change the path I took but if I was brand new and getting into trading I’d really focus on the liquidity, news risks, and if any tax advantages that may exist when choosing a market to trade.

I hope you found this guide useful. If you have any questions regarding futures please leave a comment below!