Futures Trading: Common Strategies

There are various strategies available for investors and traders to engage in futures and commodities markets. One such approach is Fundamental Analysis.

Fundamental Analysis #

The Fundamental Analysis Approach involves examining supply and demand factors to determine potential market directions. It is a long-term strategy that requires a thorough study of the specific markets you are interested in. In today’s world, with an abundance of financial news and media, you have the option to follow reliable resources that provide relevant information. However, it’s important to note that news events and circumstances are constantly changing, requiring you to stay updated and maintain a focus on your long-term goals despite volatile fluctuations in between.

Fundamental analysis involves a comprehensive assessment of supply and demand factors. Its aim is to understand the underlying economic forces that impact the demand for a particular asset. However, one of the challenges of this analysis is that the market is dynamic, and our goal is to determine a specific value that the future or commodity should be trading at from a macroeconomic perspective.

To illustrate the demand side of the equation, let’s consider crude oil as an example. Various factors contribute to the demand for crude oil, such as consumer consumption. For instance, if there is a rise in the adoption of battery-driven cars, it could potentially lead to a decrease in the price of crude oil. Another example could be cattle futures, where increased consumption of vegetable-based products, coupled with stable cattle supply, might cause prices to decline based on the principles of supply and demand.

On the supply side, let’s consider agricultural products. If farmers reduce the production of wheat and corn while demand remains unchanged, the price of these commodities should rise. Beyond physical commodities, financial futures also have their own supply and demand dynamics. During recessions, money managers and CTAs (Commodity Trading Advisors) may reduce their stock holdings and instead take long positions on indices and bonds to prioritize customer safety.

Engaging in fundamental trading requires access to reliable information and critical evaluation of the data you come across. It is a strategy more suited for individuals with a strong inclination towards economics, potentially with significant investment capital, often referred to as “deep pockets” in the futures brokerage industry. It’s important to note that while supply and demand analysis is a long-term approach, the daily and long-term market fluctuations can introduce significant noise and drawdowns.

If you’re considering trading futures from a fundamental perspective, we highly recommend reaching out to seek a second opinion on your ideas. Their expertise and guidance can provide valuable insights and enhance your trading strategies.

Options on Futures #

Trading options on futures can be approached in simple or complex ways. The simplest approach is to buy a call option if you anticipate a market to rise, or buy a put option if you expect a market to fall. Options trading is a specialized approach that can be rewarding if it aligns with your financial goals, available capital, and risk tolerance. However, we strongly advise against “selling” naked calls or puts without any positions to offset risk. Selling options without protection has historically caused more account losses than taking small losses by buying options. Options offer asymmetric opportunities, where the potential payoff for buying calls or puts can be much greater than the actual risk of losing the premium. To learn more about options on futures, we recommend contacting one of our representatives for further guidance.

The Technical Analysis Approach #

Technical analysis focuses on analyzing charts and price movements. While there are various methods within technical analysis, for simplicity, we’ll consider all approaches outside of fundamental analysis as technical analysis. These can include algorithmic trading, quantitative approaches, and statistical approaches.

Day Trading Futures (Scalpers and Short-Term Traders) #

Day trading is a strategy employed by traders who aim to profit from short-term market fluctuations and avoid overnight exposure. Day traders typically operate within very short time horizons, ranging from seconds to minutes, and close their positions quickly, often within a few ticks or points. Their objective is to capitalize on frequent market moves and take advantage of the inherent volatility in futures and commodities markets. Day traders require low margins, and certain brokers accommodate their specific needs. Although day trading may appear focused on short distances and targets, it is important to recognize that it can be highly challenging. Many beginners experience account losses due to a series of small losses. Day trading involves trading based on “market noise” rather than meaningful supply-demand fundamentals, making it more susceptible to randomness. To truly grasp micro-fluctuations, real trading experience in a live setting is necessary, as demo accounts cannot replicate real day trading encounters.

Position Trading #

Position traders hold positions overnight, pursuing long-term strategies based on fundamentals or trend-following principles. Some position traders, known as swing traders, hold positions for hours to several days, relying on technically derived setups. Others may aim to maintain positions for weeks or months, considering both technical and fundamental factors and anticipating longer-term trends. Trend followers focus on positions that can span months or even years, combining fundamental and technical analysis to identify and maximize trending opportunities in commodity futures markets.

Spread Trading #

In commodities trading, a spread refers to the price difference between two separate contracts. Intra-market spreads exist between the same commodity but in different months, while inter-market spreads occur between different commodities but in the same month. Spread traders typically engage in trades where there is some degree of correlation (or negative correlation) between the spread components. For example, when the S&P 500 rises, the Russell 2000 tends to rise as well. However, there may be instances where one commodity outpaces or lags behind another correlated commodity, leading to a widening of the spread. In such cases, spread traders take advantage of these “imbalances” by taking long positions in one contract and short positions in the other, with the expectation that the spread will revert to its average correlation.

Let’s consider a few examples of spread trading:

Going long on e-mini Nasdaq futures and short on E-mini S&P futures #

This trade aims to capitalize on short-term technical divergence or fundamental flows into the technology sector represented by the Nasdaq index. It is an inter-market spread on futures.

Going long on gold futures and short on silver futures #

Although both commodities are correlated, there may be a higher flow of capital into the gold market compared to the silver market. This is also an inter-market spread.

Shorting June crude oil futures and going long on October crude oil futures #

Since the crude oil market is deliverable, divergence may occur based on changes in supply and demand during different periods, such as changes in travel patterns. This is an example of an intra-market spread.

Note: It’s important to recognize that no trading method is inherently superior to another, and certain methods, including spreads, are not necessarily safer than outright positions. Each trading approach and time horizon carries different levels of risk and capital requirements. Longer-term strategies can be highly volatile, and fluctuations in your account may reflect that.

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