Trading futures can be a good way for seasoned traders to break into a new way of diversifying their portfolios and upping their investment skills. However, they are not very well-known among many traders, and their nature as derivative instruments may scare traders off before they even begin.
In this article, we will share what futures trading is exactly and some key approaches that traders generally use. We will also look at some benefits of trading futures. If you are keen on learning more, you can visit Saxo Bank.
What is Futures Trading?
Futures trading is an investment strategy where buyers and sellers agree to trade a specific asset at a predetermined price on a future date. This type of trading allows investors to bet on the direction of the market, whether long or short-term and potentially earn profits based on the direction of their prediction.
The mechanics of futures trading are relatively simple, though the strategy can be more complex. It’s essential to have a solid understanding of the stock market and the asset you’re trading before getting involved in futures trading. If done correctly, futures trading can be a lucrative investment opportunity, allowing you to exploit market trends and fluctuations.
Futures trading is a type of derivative trading, and traders exchange futures contract when they strike a deal. This contract is legally binding, and it obligates the parties to honour their agreement.
Benefits of Futures Trading
Before diving into futures trading approaches, it’s essential to understand the benefits of this type of investment.
First and foremost, futures trading allows for diversification in your portfolio. By investing in futures contracts, you’re not putting all your eggs in one basket – instead, you can spread your investments across different markets and assets. It helps minimise risk and potentially increase profits.
Additionally, futures trading offers the potential for high leverage. It means you can control a more significant amount of assets with a smaller initial investment, increasing your potential returns. Another considerable benefit of futures trading is its liquidity. Since futures contracts have standardised terms and are traded on regulated exchanges, they are highly liquid investments. It means that a buyer or seller is always available for the contract, making it easier to enter and exit trades.
Different Types of Approaches for Trading Futures
When it comes to futures trading, there is no one-size-fits-all approach that guarantees success. Understanding your risk tolerance, market knowledge, and personal goals is essential before choosing one.
Here are three of the most popular approaches used by successful futures traders that may inspire you:
The Trend Following Strategy involves identifying trends in the market and following them for potential profit opportunities. This approach requires disciplined risk management and the ability to recognise market patterns.
The Spread Trading Strategy involves simultaneously buying and selling futures contracts on different assets that are related in some way. By doing so, traders can potentially benefit from price fluctuations between the two contracts.
The Hedging Strategy is a risk management strategy used to protect against unexpected price movements. You can likely minimise losses if the market moves against you by taking an opposite position to your primary trade.
Advantages and Disadvantages of Day Trading vs Long-Term Investing in Futures
Both day trading and long-term investing have advantages and disadvantages regarding futures trading. Day trading involves buying and selling contracts within the same day, taking advantage of short-term price movements. This strategy allows for potentially quick profits and perhaps higher returns when executed successfully, but it does require constant market monitoring.
On the other hand, long-term investing in futures involves holding onto contracts for an extended period, usually months or years. This approach requires less frequent trading and can potentially lead to higher profits if the market trends are in your favour. However, it risks losing money if the market moves against you over time.
Technical Analysis – What Indicators are Used to Analyse Price Changes in the Market
Technical analysis is a popular approach traders use to predict price movements and identify potential trading opportunities. This method involves studying market data, such as charts and statistical indicators, to make informed decisions about when to buy or sell contracts.
Some commonly used indicators in technical analysis include moving averages, which track the average price of an asset over a specific period, and relative strength index (RSI), which shows whether an asset is overbought or oversold. Other popular indicators include Bollinger Bands, MACD, and Fibonacci retracement levels.
Risk Management Strategies to Protect Your Investments
As with any investment, risk is always involved in futures trading. To protect your investments and minimise potential losses, it’s crucial to have a risk management strategy in place regardless of the approach that you take. This can include setting stop-loss orders and automatically closing a trade if the market moves against you beyond a certain point. Diversifying your portfolio and only investing what you can afford to lose is essential.
Another risk management strategy is continuously educating yourself on market trends and news. It helps you make informed decisions and adjust your trading strategy as needed. Additionally, having a balanced portfolio with a mix of different assets can help mitigate risk if one market experiences a downturn.