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Futures

What are futures?

From Investopedia:

“A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. Futures contracts are standardized for quality and quantity to facilitate trading on a

futures exchange⁠

The buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract is taking on the obligation to provide and deliver the underlying asset at the expiration date.“

Some simple explanations from Reddit:

“In really basic terms, it's an agreement to buy or sell a certain commodity or stock at some specific price at a specific time (or within a specific time frame) in the future. Ever see that game on the price is right where they flip a card and the contestant has to guess if the next card is going to be higher or lower than the current card and if they guess right they win money? That's basically what futures trading is like.”

“Futures trading is betting on the future price of a commodity such as wheat, corn, or oil. Leverage is a technique that allows you to increase your exposure to an asset to more than you have invested in the asset. Say you buy a house for $100,000, but put down a $20,000 down payment and get a mortgage for the rest. You've effectively leveraged your assets 5X since your asset has five times the value of your investment. You're doing the same thing with futures, but you only pay a fraction of the commodity's cost for the futures contract, and the bank issuing the contract loans you the rest of the money thus creating the leverage, just like the mortgage.”

Quick video:

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Much more in depth video:

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Quick terms before you read further

Tick - The minimum price fluctuation in a futures contract. A certain number of ticks will equal 1 point of price movement, say from 99 to 100, that is 1 point. Within the point will be a certain number of ticks, example 4, price then moves by .25 (1pt/4ticks).

Tick Size - The fraction of a point a specific futures contract moves. This varies between futures contracts! Example, 1 tick = .25 of point, when price moves from 99 to 100 that is 4 ticks as it went from 99 to 99.25 (1) to 99.50 (2) to 99.75 (3) to 100 (4). The price will only move on the tick size, it will not move in between ticks. Lots of variation in tick size, make sure you understand the contract you are trading before ever trading. Example sizing, check exchange for latest.

Futures Product

Contract Size

Tick Size

Tick Value

Per Point

E-Mini S&P 500 (ES)

$50 x index

0.25

$12.50

$50.00

E-Mini NASDAQ (NQ)

$20 x index

0.25

$5.00

$20.00

There are no rows in this table

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Point - Futures prices move by ticks and not dollars due to leveraged nature. 1 point of movement in price does not equal $1.

E-Mini - The regular size contract

Micro - 1/10th the size, so 1/10th the $ for the same move as an E-Mini

Leverage - Futures are leveraged, meaning your money is being used in multiples of what it is worth. The amount of leverage varies between futures contracts. Example, 1 point of movement is = $20 and tick size is .25, that means 1 tick is worth $5 and 4 ticks = 1 point which is $20. So a price movement from 95 to 100 = 5 x $20 or $100 for 5 points of movement. A stock going from $95 to $100 would move $5 vs $100 in the example above, at 20x leverage.

Regular Trading Hours (RTH) - The time when the normal US stock market is open, 9:30am to 4pm ET. Futures trade 23 hours a day from Sunday 6pm to Friday 5pm with no trading between 5p and 6p.

Overnight (ON) or after hours - After 4pm until 9:30am, the time between the regular trading hours.

Margin Requirements - The amount of money required to open a futures contract from your broker. Many brokers have different rates between RTH and Overnight hours. Example $500 during RTH and $1,200 during ON. So if you have a $1000 account and are current trading 1 contract you will not meet the requirements to hold that contract during the ON hours. You will likely be liquidated which means your broker would execute the other side of the trade to close your position. When you get liquidated, they will charge you for that must likely.

Long - aka going long. Buying a contract(s) in anticipation the price will rise. Sell at a higher price for profits.

Short - aka going short. Selling a contract(s) in anticipation the price will fall. Buy at a lower price for profits.

Bullish - Bias to upwards price movement.

Bearish - Bias to downwards price movement.

Why Trade Futures?

No pattern day trading (PDT) rules as with stocks. PDT rule requires you to have at least $25,000 in your account. According to

FINRA rules⁠

, you’re considered a pattern day trader if you execute four or more "day trades" within five business days.

Lower account minimum size, you’d only be required to keep the amount of money your broker requires per contract plus a bit of room for losses so you can still stay above minimum margin. Example - $1,848 for min margin (each broker has its on requirements but this is the overnight requirement as for Nov 2023) on a MNQ per contract. If you have $1200 in your account you won’t won’t be able to trade a single contract. Some brokers have different day trading rates that are much lower but this comes with great risk. I think it is safest to trade the number of contracts that matches with the overnight rate.

Beneficial tax implications vs stocks, futures profits are taxed 60% at your long term capital gains rate and 40% at your short term capital gains rate (income tax rate).

No Wash-Sale rules on futures contracts.

Futures are treated as

Section 1256 contracts⁠

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Very liquid market (lots of trading volume), you can easily get in an out of positions without much worry.

Very low spread. Spread is the price between the bid (price buyers are willing to buy) and ask (price sellers are willing to sell). For index futures like the S&P 500 and NASDAQ 100 the spread is usually 1 to 2 ticks (.25 to .50, 4 ticks per point), very tight.

No short sale restrictions. This means you can sell a futures contract just like you can buy a futures contract, you can easily trade both ways with no difference in function other than the side you’re on. I can sell 1 futures contract at 100 points and buy it back at 95 points, gaining 5 points vice versa I can buy a futures contract at 95 points and sell at 100 points, gaining 5 points.

Access to a very diverse set of industries, stock index, commodities (wheat, corn, etc), interest rates and more.

Why not to Trade Futures?

High levels of risk due to leveraged nature. Money can move FAST in either direction, proper risk management is paramount!

Short term trading, futures contracts have expiration dates. Your contract will get settled at the expiration if you are still holding it.

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Volatility can introduce slippage (can have slippage in other markets too).

Slippage⁠

is when a market participant receives a different trade execution price than intended. News releases can introduce price movement that is so quick it will go right past your stop loss. I’ve seen the MNQ move roughly 150 points ($300 per contract) in 1 sec on news, rare but it can happen. Algos are stronk.

Physical delivery risk if you’re trading a futures contract that is settled with physical goods! Most brokers will prevent you from doing this. You don’t want 5,000 bushels of wheat do you??

Additional Terms

Flatten - This means to close all your positions. If you have bought 1 contract and you sell 1 contract you are now flat, selling the contract flattened your position. You have no position now. Lots of software will have a flatten button and that will flatten all of your positions even if the position is not up on the screen right now. Some software this only flattens the symbol selected.

Stop Loss - An order to protect your capital. If you bought 1 contract at 100 points, to protect your capital you may set a stop loss order at 95 to sell, a 5 point loss. The stop loss protects you from excessive losses.

Risk Management - The process of preserving your capital (money) in your account. Since futures is leverage having proper risk management strategies is one of the most important aspects of your trading.

Size/Sizing - The number of contracts you’re willing to place a trade on. Sizing drastically changes the amount of money you can gain or lose. Be very careful with sizing and make sure you have a proper stop loss in place.

Exchange - The market place where futures contracts are traded. There are many exchanges -

CME Group⁠

is one of the main ones.

Market Order - is an order to buy or sell a stock at the market's current best available price. A market order typically ensures an execution, but it doesn't guarantee a specified price. Market orders are optimal when the primary goal is to execute the trade immediately. A market order is generally appropriate when you think a stock is priced right, when you are sure you want a fill on your order, or when you want an immediate execution.

Limit Order - is an order to buy or sell a stock with a restriction on the maximum price to be paid (with a buy limit) or the minimum price to be received (with a sell limit). If the order is filled, it will only be at the specified limit price or better. However, there is no assurance of execution. A limit order may be appropriate when you think you can buy at a price lower than—or sell at a price higher than—the current quote.

Stop Order - is an order to buy or sell a stock at the market price once the stock has traded at or through a specified price (the "stop price"). If the stock reaches the stop price, the order becomes a market order and is filled at the next available market price. If the stock fails to reach the stop price, the order isn't executed. A stop loss is a stop order.

More details about order types:

3 Order Types: Market, Limit and Stop Orders⁠

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Commissions - You’ll pay commissions per contract traded. These are compiled of a few different entities getting their part of the total fee. Commissions are usually listed as per side, this means one side of the trade. If commissions are $1 it will be $1 to buy or sell and then $1 to sell or buy to close the trade, so $2, this is called round trip.

How do you even trade futures?

You’ll need to setup an account with a broker and futures commission merchant. Usually this will just be one application where both accounts will be created at the same time.

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Introducing brokers (IB)⁠

- Middlemen, do not receive money directly. Most brokers are like this. Requires a futures commission merchant to clear funds. Example - Optimus Futures (IB) + Ironbeam (FCM), this is my current setup.

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Futures Commission Merchant (FCM)⁠

- Handles your orders to buy and sell futures. Look at the FCMs carefully some don’t do ACH withdrawals so you’ll have to wait for a check.

Broker Dealers - Acts as an agent, similar to a hedge fund. You won’t be using this if you want to trade yourself.

Prop Firms - These are places where you can basically “rent” capital to trade. They have some tests for you to pass before you become approved. Then you can trade with their capital. Payouts work in different ways, you’d need to look at the specific firm. One thing to remember is taxes will function different as your paid out like you’re self employed. So you won’t have the 60/40 tax benefit of a 1256 contract.

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Data Feeds⁠

- This is not required as your IB will have data but there will be options to get better data via a data broker such as Rithmic or Sierra Teton. For Rithmic you’ll likely pay a bit of commission per contract. At first you might not need this but they give you access to a lot more information and handle orders for you. Likely you won’t be able to use Sierra Teton unless you’re using their software too. You’ll get access to

Market by Order⁠

(MBO) data which has the full order book. This may give you help in spotting support and resistance levels.

Great starter video (and channel for starting out) to get you familiar with a few futures terms and some brokers:

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My recommended brokers are Edge Clear and Optimus Futures at this point. Edge Clear’s customer service was top notch but I already had an account getting setup with Optimus Futures otherwise I would have gone with them.

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Software⁠

- There are tons of different pieces of software out there to trade futures. Some of the more well known are Quantower (same as Optimus Flow from Optimus Futures), Sierra Chart, Bookmap and Jigsaw Daytradr. I currently use Optimus Flow and I am quite pleased. Sierra Chart is very impressive but you’ll spend ages fiddling around with it to get it how you want, it is pretty complex and old school. One day I might try out Jigsaw’s Daytradr as it has some features that I would greatly appreciate when trading on the DOM (Depth of Market) price ladder.

Trading

Risk 1st, profit 2nd is a saying to live by in futures trading. Futures can move fast, you must protect your capital! Without capital you can’t trade.

Trading is risky and you should trade at your own risk. You are responsible for your own decisions.

Paper Account

After researching which tools and broker to use, ask if you can get a paper trading account setup. Set the amount of this account to $4,000 if possible (or the amount you will start out with). Now figure out the software, learn all the nuts and bolts so your comfortable. If you don’t already understand a bit about how the market works start to learn about it. Learn about macroeconomics, fundamentals and technical analysis. These will all be required to understand the trading environment you’re stepping into.

Practice putting on trades. Build out the layout and charts you like to use in your software.

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(OptimusFlow aka Quantower)

Risk Management

Due to the leveraged nature of futures I highly recommend you stick to the overnight margin rates even if your broker offers day time rates that allow you to trade many more contracts at once. I’d even consider 2x those rates until you’ve proven to be consistently profitable for a couple of months at the minimum.

Make sure to start out with a small account, I’d say about $4,000 seems like a good spot that allows you to practice. Only if $4,000 to you is ok to lose. If not I’d say stay away from futures, it really isn’t for the feint of heart, any trading really.

Example:

MNQ have ~$2,000 overnight margin per contract

With a $4,000 account trade 1 MNQ, only occasionally trading two.

Depending on the time frame you end up becoming comfortable with will help you determine your stop loss. A stop loss is worthwhile as you can easily blow up your account in no time without it, again due to the leveraged nature of futures.

A good risk management plan should have clear rules on where you to set your stop loss, a hard limit on loss in a single day to prevent blowing up your account. Remember start small as you will blow up your account at least once.

Some bullet points of things I found helpful to do

Learn your tools (practice on simulated account)

Develop a risk management plan

Practice your risk management plan

Start with a small account ($4,000 is a safe size for 1 MNQ/ES contract)

Develop a daily plan to get up to speed with news to understand the environment

Review high time frame charts and keep the trend in mind

Identify key ares of support or resistance and set alerts

Journal about your trading (setups, execution quality, etc.)

What are futures?

Quick terms before you read further

Why Trade Futures?