Futures Fundamentals: How To Trade

It's important to note that futures trading is not for everyone. While futures can be used to hedge other investments, they are also used for speculation – which carries the potential for both large rewards and large losses because of leverage. Before trading futures, it’s important to do your homework so you know what you’re doing: As a futures trader, you should have a solid understanding of how the market and contracts function. You'll also need to determine how much time, attention, and research you can dedicate to the investment. Talk to your broker and ask questions before opening a futures account. (For more, see How to Start Trading.)

It’s also important to understand the risks – and to be absolutely certain that you’re financially and emotionally ready to accept any financial losses. Keep in mind, leveraged losses can wipe out a trading account in a matter of minutes. In general, futures traders are advised to only use funds that are earmarked as pure risk capital – that is, money you can truly afford to lose.

Once you've made the initial decision to enter the futures market, there are a few different approaches to consider: 

Do It Yourself 

As an investor, you can trade your own account without the aid or advice of a broker. This involves the most risk because you become responsible for managing funds, ordering trades, maintaining margins, acquiring research and coming up with your own analysis of how the market will move in relation to the commodity or underlying financial instrument in which you've invested. It requires time and complete attention to the market. (For related reading, see Introduction to Order Types.)

Open a Managed Account 

Another way to participate in the market is by opening a managed account, similar to an equity account. Your broker would have the power to trade on your behalf, following conditions agreed upon when the account was opened. This method could lessen your financial risk because a professional would be making informed decisions on your behalf. However, you’d still be responsible for any losses incurred, as well as for margin calls. Note that you'd probably have to pay a management fee for the service.

Join a Commodity Pool 

A third way to enter the market, and one that offers the smallest risk, is to join a commodity pool – an enterprise in which funds contributed by a group of investors are combined for the purpose of trading futures (or options on futures, retail off-exchange forex contracts or swaps). Your profits and losses are directly proportionate to the amount of money you invest. By entering a commodity pool, you also gain the opportunity to invest in diverse types of commodities. You are also not subject to margin calls. However, it is essential that the pool be managed by a skilled broker, because the risks of the futures market are still present in the commodity pool.