Futures Education

How do I trade futures?

As a futures trader, your trades must be executed through a registered broker like optionsXpress. optionsXpress is a Futures Commission Merchant, or FCM. FCMs are registered with the National Futures Association (NFA) to transact business in the futures markets on behalf of clients like you. When you instruct your broker to make a trade on your behalf, or when you execute a trade through the computer, the FCM is responsible for routing that trade to the appropriate trading exchange, electronic or pit.

Types of Orders

At the most basic level, you can place an order to buy a futures contract (go long) or sell (go short). However, there are many different ways to accomplish your goal of buying or selling through different order types. The most common order types, and the ones you will cover in this course, include: a market order, a limit order, and a stop order. Your decision about which order type to use will depend on your objectives and market conditions.
If you have traded equities or options, you will find there is little difference between the order types in equities versus the order types in futures. Perhaps in more complex orders you will begin to notice differences, but at the introductory level, it is very similar.
Although your broker may offer several different order types, the following are the most common:

Market Order

The most common type of order is the market order. When you enter a market order, you simply state the number of contracts you want to buy or sell in a given delivery month. You do not need to specify price, since your objective is to have the order executed as soon as possible at a price that reflects the next available current bid or offer.
When your market order reaches the trading floor (or the electronic matching engine in the case of computer-based trading) it is executed at the best possible bid/ask price at that moment.

Limit Order

A limit order specifies a price limit at which the order must be executed. In other words, you are telling the market to fill my order at this price or better. The advantage of a limit order is that you know the worst price (limit price) you'll get if the order is executed, and there is a possibility that the price may be better than your limit. The disadvantage is that your order might not get filled if the market doesn't reach that price level or if the trading activity at that price level is limited.

Stop Order

Otherwise referred to as stops, stop orders are not executed until the market reaches a given price, at which time the stop order becomes a market order. Some stop orders are referred to as stop-loss orders, which most often are used as a measure for protecting gains or limiting losses. Many times a trader will put a stop order in at a predetermined level so that if the market moves against the trader's position it will automatically liquidate the position and, to some extent, limit further losses. to some extent
Stop orders can also be used to enter the market. Suppose you expect a bull market only if the price passes through a specified level. In this case, you could enter a buy-stop order to be executed if the market reaches this point. For instance, let's say the mini-sized Dow future was trading at 10,500. You could place a buy stop order at 10,540, and when the market reached that level your order would become a market order to sell.
In addition to the type of order, it is also important to determine the duration of an order. Most orders are day orders and work only during that trading session, expiring at the end of the day. On the other hand, open orders, or good 'til canceled (GTC) orders, work until the contract expires or the customer cancels the order. Fill or kill orders are placed and then immediately canceled if they do not fill. Market on close orders place a market order at the close of the trading day.

Position and Price Limits

In order to maintain orderly markets, futures exchanges typically set both position and price limits. A position limit is the maximum number of contracts that may be held by a single market participant. For most new futures traders, position limits don't play too big a factor in your daily decisions. For example, the position limit for NYMEX gold is 3,000 contracts - it would require a large sum of money to meet the initial and maintenance margin for 3,000 contracts, not to mention the risk exposure you would have with that type of position.

Price limits, also called daily trading limits, define the maximum price range a commodity can trade in one day. Established to keep the futures market from falling or rising too quickly, the daily trading limits keep the markets in an acceptable daily trading range. For example, the CME sets the daily limit of the S&P 500 futures at 5% - meaning if there was ever a price rally or crash that was greater than 5%, the CME would close trading for a specific period of time.
The daily price limits and position limits for futures contracts appear in their individual contract specifications. Position and price limits are changing constantly to reflect current market conditions, so make sure you are aware of any changes that may happen in the futures you are trading.

Your Goal in Futures Trading

Your ultimate success in futures trading will hinge largely on your ability to develop good trading habits. Numerous expressions of market wisdom attempt to give guidance. The age old adage "buy low and sell high" may seem a bit vague, but is ultimately your guiding principle when it comes to understanding your goal in futures trading. This may sound obvious, but since it's the only way to earn trading profits, it bears repeating.
Also don't forget that in the futures markets you can easily do the reverse—sell high and buy low. Bulls start their trades with a long (buy) position and bears are initially short (sellers).
For example, if you expected a rally in July wheat futures, you might enter the market with a long (buy) position at $3.50 per bushel. Over the next two weeks, suppose July wheat futures moved up to $3.60. If you offset (closed out) your position at this price by selling July wheat futures, you would realize a gain of $500 (10 cents x 5,000 bushels) per contract.
On the other hand, you might be bearish on T-Note futures. Let's assume you shorted (sold) the December T-Note futures at 102-00. If prices then moved down to 101-00, you could offset (buy back) your December T-Note futures position and make $1,000 (one full point on a $100,000 face value bond) per contract traded.
Boiled down, when you buy low and sell high you are ultimately trying to catch the trend of the market. Trend, or a propensity for prices to move in a general direction, is one of the most fundamental concepts in futures trading. Literally speaking, without the trending nature of the futures market, or any market for that matter, trading would be no different than gambling. The trending characteristic of the market provides you an opportunity to make money, and is the single greatest factor in skewing the odds of success in your favor.