What are Futures? Definition and Examples
Description of Futures Markets and Futures Contracts
Futures are a popular day trading market. Futures contracts are how many different commodities, currencies and indexes are traded, offering traders a wide array of products to trade. Futures don't have day trading restrictions like the stock market--another popular day trading market. Traders can buy, sell or short sell a futures contract anytime the market is open. Futures traders also aren't require to have $25,000 in their account for day trading--the capital requirement for day trading stocks in the U.S..
Here's what futures contracts are, how they work, and what you need to start trading them.
What Are Futures?
Futures markets trade futures contracts. A futures contract is an agreement between a buyer and seller of the contract that some asset--such as a commodity, currency or index--will bought/sold for a specific price, on a specific day, in the future (expiration date). For example, if someone buys a July crude oil futures contract (CL), they are saying they will buy 1,000 barrels of oil from the seller at the price they pay for the futures contract, come the July expiry. The seller is agreeing to sell the buyer the 1,000 barrels of oil at the agreed upon price.
Day traders don't trade futures contracts with the intent of actually taking possession of (if buying) or distributing (if selling) the physical barrels of oil. Rather, day traders make money on the price fluctuations that occur after taking a trade. For example, if a day trader buys a natural gas futures contract (NG) at 2.065, and sells it later in the day for 2.105, they made a profit. The price of a futures contract is constantly moving as new buy and sell transactions occur.
Futures contracts are traded by both day traders and longer-term traders, as well as by non-traders with an interest in the underlying commodity. For example, a grain farmer might sell a futures contract to guarantee that he receives a certain price for his grain, or a livestock farmer might buy a futures contract to guarantee that she can buy her winter feed supply at a certain price. Either way, both the buyer and the seller of a futures contract are obligated to fulfill the contract requirements at the end of the contract term.
Day traders are not so concerned about these obligations because they do not hold the futures contract position until it expires. All they have to do to realize a profit or loss on their position is make an offsetting trade. For example, if they buy 5 futures contracts, they need to sell those 5 futures contracts before expiry.
Popular Futures Markets and Symbols
Popular index futures contracts include:
- The Emini S&P 500 index future traded on the CME. Its symbol is ES.
- The Emini Dow Jones Industrial Average future traded on the CME. The symbol for this futures contract is YM.
Here are some popular currency futures for day traders.
- The Euro to US Dollar future on the CME. Its symbol is 6E.
- The British Pound to US Dollar future on the CME. Symbol is 6B.
Here are some of the popular commodity-related day trading futures contracts.
- The 100 troy ounce Gold future on CME has a symbol of GC.
- The 5000 ounce Silver future on CME has a symbol of SI.
- The 1,000 barrel crude oil futures on CME has a symbol of CL.
Also see Best Futures Contracts for Day Trading.
The symbol is followed by another letter and another number. The letter represents the month the futures contract expires, and the number represents the year of expiry. For example, ES contracts expire in March, June, September and December. The futures months codes for those months are H, M, U and Z. So an ES contract that expires in December of 2019 has a symbol of ESZ9 (with some brokers and chart platforms you need to enter the last two digits for the year: ESZ19).
Ticks and Tick Value - How Futures Contracts Move
A tick is the minimum price fluctuation a futures contract can make. The tick size varies by the futures contract being traded. For example, crude oil (CL) moves in 0.01 increments (tick size), while the Emini S&P 500 (ES) moves in 0.25 increments. Each tick of movement represents a monetary gain or loss to the trader holding a position. How much each tick is worth is called the tick value. Tick values also vary by futures contract. For example, a tick in a crude oil contract (CL) is $10, while a tick of movement in the Emini S&P 500 (ES) is worth $12.50, per contract.
To find out the tick size and the tick value of a futures contract, read the Contract Specifications for the contract, as published on the exchange the futures contract trades on.
Capital Required, and Fees, for Day Trading Futures
To trade a futures contracts require the use of a broker. The broker will charge a fee for the trade, called a commission. Day traders want a broker that provides them with low commissions, since they may only be tying to make a several ticks on each trade.
Unlike stocks, futures day traders aren't required to have $25,000 in their trading account. Rather, they are only required to have adequate day trading margin for the contract they are trading (some brokers demand a minimum account balance greater than the required margin). Margin is how much a trader must have in their account to initiate a trade. Margins vary by futures contract, and also by broker. Check with your broker to see how much capital they require to open a futures account ($1,000 or more is usually required).
Then check what their margin requirements are for the futures contract you want to trade. This will let you know the bare minimum of capital you need. You will want to trade with more than the bare minimum though, since you need to accommodate for losing trades and the price fluctuations that occur while holding a futures position. For guidance on how much capital you need to day trade various futures contracts, see Minimum Capital Required to Day Trade Futures.
The Final Word on Futures
Futures are a popular day trading market because traders can access indexes, commodities and/or currencies. Futures move in ticks, with an associated tick value. This tells you how much you stand to make or lose for each increment the price moves. Futures contracts expire, but day traders buy and sell before expiry, never taking actual possession (or having to distribute) the underlying asset. Futures traders pay a commission on each trade they make. Each contract requires a certain amount of margin, which affects the minimum balance required to trade.
Brokers may set their own margin requirements or trading account minimums.