Last updated: October 8th, 2024
To the uninitiated, learning how to trade futures can seem mysterious. You’re betting on the price of assets and commodities that you don’t own, and that possibly doesn’t exist yet.
There’s also a contract involved. If you get it wrong, will you find yourself forced to take possession of tonnes of wheat?
Not only is trading futures more complex than trading traditional stocks, but it typically involves using leverage— which is a magnifier of risk.
Let’s learn about trading futures contracts, their pros and cons, and what you need to make your first futures trade.
(Related: Why Are Magnificent 7 Stocks Soaring)?
What Is Futures Trading?
Futures contracts are a type of a derivative product.
You trade these via regulated stock exchanges — such as ASX 24 in Australia and the Chicago Mercantile Exchange (CME) in the United States.
A futures trade represents a contractual agreement about an asset – not the exchange of an actual asset. When you buy or sell futures contracts:
- The value of the contract is derived from the fluctuating value of an underlying asset or financial instrument such as a commodity, currency, or stock index.
- The contractual ‘agreement’ secured is to buy or sell an underlying instrument at a set date in the future, at a price determined today.
(Related: Will The Australian Dollar Rise In 2024?)
If you correctly predict that the underlying market price will move higher or lower than the contracted purchase price, you’ll receive (or pay out) the difference in value.
Important!
Futures traders often use leverage, which means they use a fraction of the funds to open a sizeable position. However, they also substantially increase risk because losses are proportional to the leveraged amount (rather than the initial investment).
- Had the price dropped by just $5, you would have made a loss of $5,000.
- However, it’s likely your position would have been liquidated by the trading platform – unless you’d added funds into your trading account to top-up your margin.
Key Components Of A Futures Contract.
| Long or short position | You can bet on whether you think prices will rise or fall in the future. |
| Forward price | Predetermined price in the contract. Must be paid to purchase or sell the underlying asset at the expiry of the contract. |
| Settlement | Most futures trades are settled in cash, but there may be some cases where it’s expected that a physical commodity is actually delivered. |
| Expiration date | The last day you can trade the contract before you need to settle. |
| Margin and leverage | Most brokers let you trade on margin, enabling a leveraged trade where you borrow funds from the futures broker to take a larger position — provided you have enough funds to cover potential losses from the trade. You’ll need to meet the broker’s specific margin requirements to keep your trade open or risk a margin call or liquidation. |
How Do Australian Futures Contracts Work?
You can buy and sell futures contracts through a stockbroker (including online brokerages).
Your broker will create a standardised, legally binding contract that sets out details about the underlying asset. Specifically:
- Minimum price movements.
- Number of assets the contract represents.
- Date the contract expires.
- How it will be settled.
Important!
Different markets measure units of underlying assets in different ways. They also vary in how they calculate price movements.
At the futures contract’s expiry date, the seller must sell, and the buyer must buy.
Therefore, speculators will typically close a future trade before expiration — when they believe it’s most profitable to take advantage of a price movement or to cut their losses.
(Related: How To Buy Apple [APPL] Stocks).
As a futures contract gets closer to its expiry date and time of delivery, its price in the market naturally converges with the current spot price.
Expert Tip.
You can trade futures contracts at a smaller contract size by choosing E-mini and Micro E-mini futures available for some equity indices, gold and currencies. E-minis are one-fifth the size of a standard contract, which lowers the barrier to entry for traders by lowering your margin requirements.
Are Futures Trades The Same As CFDs?
A contract for difference (CFD) is a type of product offered by some brokers that enables you to speculate on changes in the price of an underlying asset — and profit from the difference in value.
Related: What Is The Average Salary In Australia?)
Instead of entering a contract with a futures seller, your contract is with the CFD provider. Each broker providing CFDs may have different terms and conditions.
Important!
ASIC regulates Australian licensed brokers offering CFDs, limiting leverage ratios and putting controls in place to prevent trading accounts from going into a negative balance. Overseas brokers may not have the same checks and balances in place.
What’s The Difference Between Futures And Options?
An option is also a type of derivative product. It is a contract based on the value of an underlying asset.
- Like futures, options are used for both speculation and hedging.
- Unlike futures, when an options contract expires, the holder isn’t obligated to buy or sell the underlying asset. Instead, they must decide whether to exercise their option by the expiration date or not.
(Related: Best Investing Podcasts In Australia).
Why Trade In Futures Markets?
The two main reasons to trade in futures are:
- Speculation. The goal of making a profit based on the changes in a future’s value.
- Hedging. Using futures contracts to ‘insure’ against potential movement in prices.
Trading Futures For Speculation.
Speculators include professional and individual traders, who may be attracted to futures trading due to:
- The potential to make profits faster by trading futures on frequent day-to-day price movements.
- More opportunities to make profits by taking both long and short positions across a wide variety of financial instruments. Plus, futures traders have almost 24/7 access to major markets due to futures exchanges’ extended hours, and without any pattern day trader limits for the US market.
- The potential to make bigger profits without risking as much capital, through leveraged trades.
Important!
Speculators who trade futures take on considerable risk. They must factor in changes in the supply and demand of underlying commodities caused by unpredictable events like natural disasters and political upheavals. The price of oil, for example, has fluctuated considerably in the last 5 years – not in small part due to the war in Ukraine and the COVID-19 pandemic.
Trading Futures For Hedging.
Individual traders can hedge their exposure to risk through an opposing position via a futures trade.
Hedges with a direct stake in the underlying asset are the most common. For example:
- A farmer might sell futures to protect their business by locking in current prices – as a hedge against downward price movements of the commodity they farm. If prices drop before the farmer gets produce to market, the gains made on futures contracts provide an offset.
- A large food processor who depends on wheat might buy futures contracts to cover the wheat needed to meet production targets as a hedge against the risk of wheat prices increasing. If wheat prices increase, the company can use gains/assets delivered from a futures trade to mitigate increased production costs.
(Related: Why Is The Cost Of Living In Australia Rising?)
Steps To Becoming A Futures Trader In Australia.
You can trade futures across global markets from Australia by following these steps.
1. Choose A Market To Trade In.
You can trade futures across a variety of markets, including:
- Commodities including metals, energy and agricultural products.
- Currencies, Forex and cryptocurrencies.
- Financial markets including stock market futures, assets linked to interest rates and bond futures.
When choosing which futures market to play in:
- Pick 1-2 markets you already know as a starting point to reduce your learning curve.
- Prioritise markets with high levels of activity and liquidity for fast and easy trade execution.
(Related: What Bitcoin Halving Means For Crypto).
2. Open A Futures Brokerage Account.
Open a trading account with an online trading platform that allows futures trading and provides international reach across multiple futures exchanges.
For example, two brokers Australian retail traders can use to execute trades include:
- Interactive Brokers lets you trade futures products across more than 100 international markets.
- Bell Potter offers access to both local and major international futures exchanges.
In addition to low fees, when comparing brokers, pay special attention to the initial margin requirement for futures trading.
Important!
In Australia, all futures brokers must be licensed.
3. Plan Your Futures Trading And Exit Strategies.
Determine your method for identifying promising trades and the futures trading strategy you’ll employ.
Will you speculate based on the direction you think the market is heading (e.g., a long position if you’re bullish, and a short position if you’re bearish) or attempt a more complicated spread trading strategy?
Will you use futures to hedge other investments?
Expert tip.
If you’re new to futures, don’t hesitate to use a practice trading account to do a trial run of a futures trade. Do this even if you’re an experienced trader.
4. Place Your Trades.
Use your trading account to select your market and open a futures trade and then:
- Decide whether to go long or short.
- Choose your position size and amount of leverage.
- Set your stop-loss and limit orders, if you want to close your position automatically when it reaches a certain price (or drops to a certain level).
(Related: How To Start Day Trading In Australia).
5. Monitor And Close When It Makes Sense.
Keep track of whether a future’s price movements match your expectations. Be prepared to close a trade to avoid heavy losses (if you haven’t set stop or limit orders).
If you receive a margin call, consider that it may be a sign your trade is a bad one. Don’t throw away good money trading futures unless you can objectively justify keeping a position open.
What Does It Cost To Trade Futures?
Fees and commissions differ between brokers.
Some don’t charge commissions on futures trading.
Important!
To use leverage, you’ll need to meet the initial margin requirements of your online futures trading broker by having sufficient funds in your trading account — which can range from a few thousand to tens of thousands.
In addition to paying for losses made on a trade, be aware that trading futures on margin means you may be liable for fees that include:
- Liquidation/insurance fees – if you fail to add funds when you receive a margin call.
- Overnight interest fees – to keep a position open overnight (for CFDs only).
What Are The Risks Of Futures Trading In Australia?
The desire to obtain significant profits from a smaller outlay can be strong.
However, leveraged positions are inherently riskier because they also amplify losses.
Australian licensed brokers have liquidation processes in place — where losing trades are closed before a trading account reaches a negative balance — to help mitigate the risks involved when losses exceed the available equity.
Important!
Successful futures trading requires a sophisticated knowledge of the futures market and its movements, so it’s not recommended for novices or beginner investors and should be reserved for those who can dedicate time and attention to research and monitoring their trades.
Frequently Asked Questions About Trading Futures.
Here’s where most beginner traders typically get unstuck.
What Are Transparency Futures?
Transparency futures offer a level playing field for both retail traders and market makers. Futures traders receive data directly from the exchange, so they get the actual market value—not a broker’s interpretation.
What Is The Sydney Futures Exchange (SFE)?
The SFE started trading in 1960 under the Sydney Greasy Wool Futures Exchange (SGWFE) tofacilitate hedging for Australian wool traders. Back in 2006, the Australian Stock Exchange (ASX) merged with SFE Corporation.
Jody
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