7 Tips Every Futures Trader Should Know

In the world of futures trading, success can mean significant profits—but mistakes can be extremely costly. That's why it's so important to have a strategy in place before you start trading. Here are seven tips for how to proceed.

The first tip simply can't be emphasized enough: Plan your trades carefully before you establish a position. This means having not only a profit objective but also an exit plan in case the trade goes against you.

The goal here is to minimize the possibility you'll need to make important decisions when you're already in the market with money at risk. You don't want emotions like fear and greed dictating your moves by luring you into holding onto a losing position too long or exiting a profitable position too soon.

A carefully wrought trading plan that includes risk-management tools, such as stop orders, which we'll discuss below, or bracket orders, can help protect you from such errors. For example, say you bought one contract of December silver at $20 per ounce. With a bracket order, you could set a stop-loss exit at $18 per ounce and a profit exit at $25 per ounce. That way, you're attempting to limit your risk to $2 per ounce, while maintaining a profit potential of $5 per ounce.

Committing to an exit strategy in advance can help protect you from significant contrary moves. Too many traders try to use "mental stops," picking a price in their heads for when they'll close a position and minimize their losses. But these are too easy to ignore, even for the most disciplined traders.

To make your commitment more firm, consider trading with stop orders. The idea is to decide on a bailout point first, and then set a stop at that price.

One-Triggers-Other (OTO) orders allow you to place a primary order and a protective stop at the same time. When the primary order executes, the stop is automatically placed. This frees you from having to constantly watch the market, and it relieves you from having to worry about entering your stop order at the right time.

Just remember, though, there is no guarantee that execution of a stop order will be at or near the stop price. Stops are not a guarantee against losses—markets can sometimes move quickly through them. Also, with futures, it's important to remember that, unlike with other products, stop orders aren't guaranteed to fill at all due to price protection points, which are a predefined price range where an order should execute to avoid selling at an extreme price level. (The CME Group has additional information on protection points and how they work.) But, in most cases, a stop order can potentially help traders remain focused on their strategy when a trade goes awry.

Don't spread yourself thin by trying to follow and trade too many markets. Most traders have their hands full keeping abreast of a few markets. Remember that futures trading is hard work and requires a substantial investment of time and energy. Studying charts, reading market commentary, staying on top of news—it can be a lot for even the most seasoned trader.

If you try to follow and trade too many markets, there's a good chance you won't give any of them the time and attention they require. The opposite is also true—trading just one market may not be a terrific approach either. Just as diversification in the stock market has well-known benefits, there can be advantages to diversifying your futures trading too. Bear in mind, however, that while diversification can sometimes reduce the volatility of an overall portfolio, it doesn't offer protection against losses.

For instance, suppose you expected gold prices to decline but the cocoa market to rally. If one of those expectations proved wrong, while the other was right, you could potentially offset a loss with a gain.

If you're new to trading futures, don't floor the accelerator. There's no reason to begin trading five or 10 contracts at a time when you're just beginning. Don't make the beginner's mistake of using all the money in your account to purchase or sell as many futures contracts as you absolutely can. Occasional drawdowns are inevitable, so you should avoid establishing a large position where just one or two bad trades can wipe you out financially.

Instead, start slowly with one or two contracts and develop a trading methodology, without the added pressure that comes with managing larger positions. Tweak your trading as necessary, and if you find a style or strategy that's working well, then consider increasing your order size.

If you're a new futures trader or a veteran who has hit a rough patch, you might also consider downsizing your contracts. For example, if you wanted to trade S&P 500 futures, you could purchase CME Group's E-mini contracts. These were originally created to be one-fifth the size of a standard contract—hence the name E-mini. (The standard contract for S&P 500 futures, which is no longer available from CME, was $250 times the value of the index; the E-mini contract is $50 times the value of the index.) But they also sell Micro E-mini contracts for the same index, with a contract size one-tenth of the flagship E-mini, or $5 times the value of the index. There are other Micro E-mini products with the same one-tenth contract size for a wide variety of sectors.

Trading opportunities present themselves in both rising and falling markets. It's human nature to look for chances to buy, or "go long" the market. But if you're not also open to "going short" in a market, you might unnecessarily limit your trading strategies. Here's an example: Suppose a trader believes the price of crude oil is going to fall and looks to take a position by selling December crude oil futures at the current price of $50 per barrel, with the hope to buy back the futures contract at a later date for a profit if the price falls below $50 per barrel.

With futures, you can sell the market or buy the market. You can buy first, and then sell a contract to close out your position. Or you can sell first and later buy a contract to offset your position. Whatever order you sell or buy in, you'll have to post the required margin for the market you're trading. So, don't overlook opportunities to go short. However, shorting the market also comes with the potential for unlimited loss because there's theoretically no limit to how high a market can move.

If you're hit with a margin call, it's probably because you've stayed with a losing trade too long. So, consider treating a margin shortfall as a wake-up call that you've become emotionally attached to a position that's not working as planned. Rather than transferring additional funds to meet the call or shrinking your open positions to reduce your margin requirement, you may consider exiting the losing position completely. As the old trading expression goes, "cut your losses" and look for the next trading opportunity.

Futures margin, also known as a "performance bond," is the amount of money you are required to deposit in your futures account to establish and maintain a futures position. Futures margin is not a loan. If at any given time the funds in your account drop below the minimum regulatory requirement, or "house" margin requirements, you may be required to immediately deposit additional funds to maintain your position, or your position may be liquidated at a loss. You will be liable for any resulting debits. Charles Schwab Futures and Forex LLC may increase its "house" margin requirements at any time and is not required to provide you with advance notice of such requirement changes or liquidations initiated by Schwab. You are not entitled to an extension of time on any type of margin call.

Don't get so wrapped up in market action that you lose sight of the larger trading picture. You should obviously monitor your working orders, open positions, and account balances. But it may not be wise to hang on every uptick or downtick in the market. Not only can you drive yourself crazy, but you could also be thrown by small zigzags or whipsaws that appear formidable and significant in the moment but ultimately prove to be just intraday blips.

In other words, try to maintain some longer-term perspective. Lengthening the duration of your trades could work better than trying to trade every move in the market.