What are futures? Futures are also called futures contracts. This is exactly what they are, a contract between two parties to buy and sell something in the future. Every futures contract has a specific end date, or expiration, and when that date comes the seller must sell or the buyer must buy. No exceptions!
So what exactly is being bought and sold? There are many types of assets traded on futures exchanges. Some examples include:
Stock Index futures: Dow Jones futures, S&P 500 futures, Nasdaq futures and more
Precious Metal futures: Gold futures, Silver futures, Copper futures and more
Energy Commodity futures: Natural Gas futures, Crude Oil futures and more
Agricultural Commodity futures: Wheat futures, Corn futures, Soybean futures and more
Currency futures: Australian Dollar futures, Euro futures, and more
And lots more!
Companies often use futures to hedge, or protect, the price of physical commodities they use for their business. But this is only one type of entity that trades futures.
Another type are futures traders. Futures traders are speculating on the direction that their underlying asset will move in the future. Just like in stocks, you would buy a futures contract if you expect the price to go up and you would sell if you expect it to go down. Futures traders don’t usually hold their contract until expiration (because this sometimes means you would have to accept physical delivery of the asset, like oil or wheat!). Futures traders ride the short term price changes that occur up until expiration and then simply close their trade for either a profit of loss.
Futures trading used to be mostly out of reach for retail traders as the contract sizes were so large. But with the addition of mini and micro contracts there are futures with margin requirements as small as $200! For example, at the time of this video, a mini corn contract only requires $187 of margin with my broker.
Just like in other markets, like options or forex, futures traders can use leverage in their trading. Using leverage means that you can control a much larger position size with a smaller amount of your own money. For example, right now with my broker, for a Micro E-Mini Nasdaq position valued at $22,322 you would need to put up a margin amount of $1,760. Using leverage can be a very powerful double-edged sword that can amplify both your profits and your losses and should be used with caution.
There are a few benefits to trading futures that I’d like to highlight now:
- Unlike stocks, you can easily buy or sell futures. This means you can take advantage of whichever direction the market is heading.
- The futures market is open 23 hours a day, 5 days a week. You have a lot of flexibility to fit futures trading around your lifestyle.
- As mentioned before, you can use leverage to trade futures, allowing you to amplify your profits (but also your losses!)
- There is no limitation on how many trades you can make. There is no pattern day trade rule in futures.
- In the United States, futures are unique as far as their tax benefits, even over forex. This is a big reason why I personally trade futures. Whereas stocks, forex and options are taxed as normal income, futures are taxed differently. The first 60% of your futures gains are taxed at the long-term capital gains rate and the remaining 40% is taxed as normal income. This can end up being a huge difference! Here is an example:
A trader named John makes $100,000 trading forex and his tax bracket is 25%. He owes $25,000 in taxes.
A trader named Sally makes $100,000 trading futures and her tax bracket is 25%. The first $60,000 is taxed at only 15% and the remaining $40,000 at 25%. She ends up paying only $19,000 in taxes. $6,000 less than John!
While I started off trading forex, I eventually added in and then transitioned completely to futures because of the benefits and the fact that I could still utilize all of my technical analysis knowledge just as effectively. This might not matter to you (especially if you aren’t in the United States), but is definitely something to think about!