So You Want to Start Trading Futures: What is it & What Do You Need to Know?

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Most of us are already familiar with stock trading, and it is usually how we begin our investment journey. However, stock trading is just the starting point. There’s a lot more to explore when you invest with Tiger Brokers. For those looking for the potential for higher returns through leverage and using futures as a hedging tool in an uncertain market condition, futures trading can be an exciting option to consider.

As a professional hedging and leverage tool, futures are suitable for some investors, who might have an inverse view for the short term. Given its wide variety of applications, futures are also a tool used by professional hedge fund managers.

Of course, using leverage can also mean that you may be exposed to higher risks. For those who are keen to get started with trading futures, the key is to learn how to make a meaningful trade that meets your hedging or leveraging need to really up your game.

Read on to find out more!

 

What are futures?

Futures are derivatives, which means that they aren’t actually assets, but rather contracts that are tied to an underlying asset. Underlying assets can include a wide range of products, from financial instruments such as stocks, bonds, and currencies to commodities like gold to interest rate to index, even weather or emission (Carbon Emissions Futures).

Here’s the twist — the futures contract is an agreement that you will buy or sell the underlying asset at an indicated price on the expiration date of the contract. The price you pay will be that indicated in the futures contract regardless of the actual price of the asset at the time you buy it.

So, if the actual price of the asset rises to above the price indicated in your futures contract, you make money because you get to buy it at a discounted price. Traders like futures for many reasons. Hedging is one of them as futures can be used to hedge against losses from existing trades by “setting” a price that can limit their loss in case of any unwanted market movement.

Example 1
A professional fund manager is able to hedge their SG/US share portfolio against any shorten market correction or fall, using Index Futures. They’ll first calculate the amount they want to hedge and find a representative index. If they want to hedge a $100k stock portfolio, they’ll sell the same value of their chosen index futures. Before the futures contract expires, the fund manager can buy back the contract or roll onto the next period to continue this hedging strategy.

Example 2
For those who want to hedge against exchange rate risks, for example to hedge against the USD depreciation, they can use currency futures/dollar index futures. Similar to how currency pairs work, currency futures state the price in one currency in relation to another currency that can be bought or sold at a future date. By hedging against exchange rate risk, one can protect themselves from depreciation of their core currency and maintain their return of the investment portfolio.

 

Know the risks of trading

Futures trading is a form of margin trading, in which you deposit a portion of margin to buy/sell a contract that will be settled when you liquidate or when it expires. Traders need to know that it’s possible to lose more than what they put down in trading capital, due to the margin nature and functions.

Most of the contracts will be cash-settled and liquidated by the expiry date of the contract. (Note: Tiger does not support the physical delivery of the contracts. Futures traders can benefit from margin and two-way trading, which gives them the flexibility to hedge and leverage their investment in the short term.)

How do leverage and margin work in futures contracts?
Futures, just like other trading products, can be traded on leverage, in which the trader can use a relatively small amount of capital to control a much larger contract value. The margin is also referred to as the initial margin, security deposit or performance bond in the futures market (about 3% to 12% of a contract’s cash value).

As you might have guessed, when trading on margin, you have the potential to win or lose more than the cash you have put up for the trade. This may also mean that in unfortunate instances, you may lose more than your initial capital and be exposed to the risk of losing money you do not have.

On the other hand, when used as a hedging tool, futures can actually mitigate the risks of losses from your other trades. This can reduce the impact of your investment portfolio performance when the market is against your current investment.

 

What are some common scenarios & strategies when trading futures?

There are also lots of trading scenarios traders use to make money from futures, and surely some closely guarded secrets devised by professional traders for their own trades. A good starting point would be to learn some basic strategies before using or adapting them for your own trading practices.

Here are some of the more common scenarios and strategies:

 

Hedging using futures in a falling market

You own some shares of company X, but the market movement isn’t favourable so its value falls. However, you don’t wish to sell these stocks of company X just yet, in view of the potential growth of this company and the promising dividend yield, so instead you decide to hedge using futures. So, you take a short position on an equivalent value of shares of company X in a futures contract.

If the price of a stock is currently $10, you can hedge against decline by short-selling a futures contract of a similar value to your portfolio. Any price drop on the shares, will also reflect a drop in the futures contract — through short-selling you could make a profit in futures to cover your losses in shares, until your view changes and you decide you no longer need to hedge the position(s).

 

Taking a short-term view on leverage and cost-savings

As you’re using leverage with futures, you’d only need to put up a fraction of cash (your margin) to trade much larger amounts. Of course, risk and return are proportionate, so traders must make sure they know how to manage their risks and use a trading platform with risk management features in place. This is the advantage traders have when trading futures over normal stocks, the latter with which they need to purchase at full price.

For someone who wants to buy Company Z stock that’s priced at $100, they’d need to spend $10,000 to purchase one lot of 100 shares. However, if they buy a futures contract, they’d only need a fraction of that amount of capital ($1,000 for a 10% margin) to hold the same value of shares. If the Company Z stock price increased by $10 per share, both traders would have made $1,000 profit, but the one who bought into the futures contract used far less capital to make the same amount. On the flipside, if Company Z’s stock price decreased by $10, losses will be $1,000 too.

 

Fundamental trading

Traders can use fundamental analysis to determine the “true” value of a futures contract. By analysing factors such as the economy, interest rates, the GDP and market conditions, they try to predict price movements and identify futures contracts that are undervalued, such as gold, crude oil, copper and so on.

 

Trend-following

This technique involves identifying trends and then entering the market in hopes that the trend will continue.

 

Trading the range

Range-bound assets bounce repeatedly between two prices, a high and a low. This allows the trader to predict and profit from these price movements as long as the asset remains range-bound, such as by buying when the price is near the high or low limit of the range — leveraged trading and low trading cost allow these trading strategies to work well for some active and high-risk traders.

 

Where to trade futures?

The first step on your futures trading journey is to open a trading account with a broker.

You can do this through an online or mobile broker such as Tiger Brokers. Simply download the Tiger Trade app on your mobile phone, complete the quick and easy sign-up process and you’re ready to trade!

Opening an account with Tiger Brokers is quick and cost-effective. For one, Tiger Brokers offers commission-free trading for futures so you can maximise your profits. It also does not charge any custody fees, deposit and withdrawal fees, currency exchange fees, inactivity fees or account maintenance fees.

You can benefit from a wide range of financial products available via the Tiger Trade app, so traders of all stripes (geddit?) can find their trading niche. The app also makes it easy to trade on the go with a professional, clear and user-friendly interface with charts to help traders decide on the entry and exit levels when trading options.

You can check real-time market data, quotes and news and then place trades on your phone — there are also trading features like in-depth analytics and candlestick charts, so you can analyse and place advanced trades. Did you know that there’s an intraday lower margin required during the market active time period? This will allow users to perform intraday trades with lower initial capital requirements.

Best news: Tiger Brokers is charging zero commission for futures trading until the end of the year!

To take advantage of this offer, download the Tiger Trade app, set up a Tiger Brokers account and activate your commission-free futures trades.

 

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