Five Tips for the Beginner Futures Trader
Choosing to invest is more than an isolated decision to throw some cash at the stock market. You have several options at your disposal, and you will likely grow into a more experienced investor with a robust portfolio featuring a range of new products.
When you want to become a futures trader, there are many things to consider. These five tips for beginning futures traders will help anyone build a strong portfolio, earn an income, build wealth and/or diversify.
What Are Futures?
Futures are contracts designed to control costs for traders. This means futures differ quite significantly from options trading.
A futures contract involves a buyer and sell wherein the buyer agrees to sell an asset at a specific price…in the future. The contract sets the price and the date of the sale, giving the buyer the option to cash out prior to the maturation of the contract.
The buyer is not carrying any inventory in the interim, and cashing out allows the buyer to profit on the difference between the contracted price and the current market value of the asset.
Unfortunately, investing is not as simple as settling every future for cash and backing up the Brinks truck to your house. Use these five tips to make the most of your futures.
1. Create a Futures Trading Plan
Everyone needs a futures trading plan. Whether you are an expert or novice trader, an investment plan is the first and most important part of the process.
Your trading plan should have:
- A profit objective
- An exit plan
A profit objective and an exit plan help you avoid losses and increase profits. Decide how much money you believe you should be making on each contract. Then, determine when you would get out of a contract depending on how the market shifts.
The most important part of this process is a bracket order. A bracket order allows you to:
- Set a low price to cash out and prevent losses
- Set a high price to cash out and increase profits
Narrow Your Focus
In addition to building an investment plan and protecting yourself, you should also narrow your focus. This does not mean you only invest in, for example, silver. However, it might mean you only trade futures on precious metals.
Narrowing your focus helps you research a singular industry or commodity group rather than throwing your money across the market at anything that sticks. When you spread yourself too thin, you are more likely to make mistakes and/or lose money.
Pace yourself by investing in a few futures at a time. You want to create a portfolio you can manage and understand. Investing in just a few futures allows you to watch them all and profit. If you don’t pace yourself, you will get overwhelmed without even realizing how much debt you’ve absorbed or how much money you could lose in a short period of time.
2. Avoid Mistakes Whenever Possible
Everyone makes mistakes. In fact, the best traders have screwed up and recovered from it—lived to tell the tale. However, you should do everything you can to avoid mistakes. Avoid these mistakes at all costs, carefully curating your portfolio to prevent disaster.
Not Sticking to the System
You went to great lengths to create a trading system, and you should stick to that system as long as it is working. The best traders have a system that works for them because they understand it and it generates profits.
Yes, you can make small changes to your trading plan, but you should keep the plan until it is clear it no longer works.
Not Protecting Your Position
As mentioned above, you can use bracket orders to protect yourself by setting a low price to sell off your futures as the price falls. When you don’t protect your position, you could lose all your money. Plus, you must protect yourself by using the appropriate plan and only investing in things you understand.
A Lack of Focus
Overextending yourself reduces your level of focus. You should narrow your focus, consider every investment carefully and never overextend to the point that you take on too much debt, cannot keep up with your investments or do not have time to research your investments.
Learning From Margin Calls
If you get stuck in a margin call, perhaps you held on to the future for too long. It’s ok if this happens once, so long as lessons are learned to reduce the chances of seeing a repeat.
Close Minded Investing
You should not try every single investment tip you get, but you should be willing to try new things. Keeping an open mind allows you to consider all your options, do the research and expand your portfolio organically.
3. Value Futures Properly
When you value futures, you must consider how the underlying commodity changes in price over time. Consider the inherent costs of handling these commodities. You must also determine pricing based on the total number of units in the contract and the price quoted.
For example, a futures contract on coffee at $5 with 1000 units in the contract totals $5000–not $5.
As you value futures contracts, remember that you must research the commodity so you know what a fair price is. Overpaying on a futures contract makes it difficult to make money, and shorting an asset that is not likely to drop far will not result in the profits you desire.
Keeping track of global news is another crucial aspect. Global events such as lumber shortages can greatly impact the price of futures contracts when trading, especially when trading commodities.
4. Diversify Your Investments
Diversify your portfolio as much as possible so that you can avoid major losses. Diversity allows one investment to falter (generally through no fault of your own) without ruining your finances.
Long and short positions are acceptable. You can stay in long-term futures knowing they will mature and produce profits. You can invest in a commodity that should rise in value (some see gold as a fitting prospect), or you can short that position, waiting for the commodity to fall in price. The choice is yours and both are helpful when you have a robust and diverse portfolio.
5. Get Started with a Futures Broker
While there are certainly many futures brokers out there, this doesn’t mean they all feature the same offering. Only the leading futures trading platforms will provide you with the tools and research capabilities which are required to execute a successful strategy. Choose your broker carefully!