For many investors, the futures markets, with all of the different terms and trading strategies, can be very confusing. There are significant profits to be made in the futures markets but it is important that you understand how the different types of markets work and how you can achieve those profits consistently. This article explains how each market works and the different strategies that you can use to make money.
How Can You Be Successful?
The futures markets are where hedgers and speculators meet to predict whether the price of a commodity, currency or particular market index will rise or fall in the future.
Like any market, this one has risks when trading, but the potential to see both short- and long-term gains can be substantial, thanks in part to the huge amounts of volatility that these markets are known for having. Here are a few of the different futures markets, along with different strategies that you can use to make money in them.
A commodity is a physical product whose value is determined primarily by the forces of supply and demand. This includes grains, energy and precious metals, just to name a few. Commodities trade in a centralized market, where investors and speculators predict if prices will rise or fall by a predetermined time.
One strategy you can use when trading commodities is to use straddles. A straddle is constructed by holding the same number of calls (where you are speculating that price will rise) and puts (where you are speculating that prices will fall) with the same strike price and expiration date. The basic idea here is that you think prices will remain volatile in the future, either moving up or down.
Another strategy one could use is to buy a call option. In general, you would purchase calls when you believe the price of the underlying asset will appreciate in the near future. Conversely, you would purchase a put option if you believe the price of the underlying asset will decline in the near future. (For more on commodities, see An Overview of Commodities Trading.)
As with commodities, when you trade currencies you are speculating that the prices of a particular currency will rise or fall in the future. One commonly used strategy to trade currencies is scalping. Scalpers attempt to take short-term profits off incremental changes in the value of a currency. Doing this over and over again means that your profits will continue to add up over time, giving you significant total profits when you add all the small profits together.
In general, your time frame can be as short as one minute or may last several days. A scalping strategy requires strict discipline in order to continue making small, short-term profits while avoiding large losses. (To read more on scalping, read Introduction to Types of Trading: Scalpers.)
Indexes and Interest Rates
Timing strategies are extremely popular with investors who trade index and interest rate futures. One of the most highly traded index futures contracts is the S&P 500 index futures contract.
Futures contracts on interest rates are also very popular contracts. Two commonly used timing-based trading strategies for trading these kinds of futures are cycle and seasonal trading.
A cycle trading strategy is implemented by studying historical data and finding possible up and down cycles for an underlying asset. Two commonly used cycles for stock index futures are the 23-week cycle and the 14-day cycle. Studying the price trends associated with cycles can lead to large gains for savvy investors.
Seasonal trading, on the other hand, is when you attempt to trade the seasonal effects that take place in the futures markets. Historical data suggests that many markets, sectors and commodities trade at varying levels throughout the year and show similar patterns year after year. Knowing these different seasonal trends is another effective way to make money trading futures. (For more on seasonal trading, see Capitalizing on Seasonal Effects.)
Try It Out
Getting started in the different futures markets can seem daunting. One way that you can learn as you go without putting any of your money at risk is to start out paper trading. Paper trading is done by mimicking trades by yourself (or with a market simulator) until you feel that you are comfortable enough to begin actually trading.
A good way to start is by concentrating on these four different areas. This will help build your knowledge as you go along without increasing your overall amount of risk. Then, as you feel that you have mastered these areas, try expanding into trading other types of futures.
The Bottom Line
Trading the different futures markets can be very rewarding but challenging. For young investors, there are many different markets and strategies that you can use to be successful, including the ones we discussed here. By doing your research and making sure you understand how futures work, you will have the opportunity to enjoy a great deal of success trading in the futures market. (To read more about the futures market, see our tutorial Futures Fundamentals.)
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