Futures Trading

Futures trading is the buying and selling of futures contracts on a recognised exchange, such as the Sydney Futures Exchange (SFE).

Futures trading gives investors the ability to control a large investment for a small initial deposit. Accordingly, futures are a highly leveraged investment vehicle.
With a preliminary interest in trading futures, it is common for Australians to have many questions about the Australian Futures Markets. Below are the most common questions and their answers.

These questions may include:

• What is futures trading?
• What is a futures contract?
• How much does it cost to buy a futures contract?
• What are the variation and margin calls?
• Who are futures brokers, and how can they help me?
• How do I trade?
• Do I buy or sell?
• How can I minimise risk?
• How does a trading account operate?
• Do I have what it takes to become a successful trader?
• What is futures trading?

Futures trading is the buying and selling of futures contracts on a recognised exchange, such as the Sydney Futures Exchange (SFE). Futures trading gives investors the ability to control a large investment for a small initial deposit. Accordingly, futures are a highly leveraged investment vehicle.

Futures contracts are traded on currencies, market indices and even some stock. Of particular interest are futures traded on the Share Price index (SPI). Currently, one SPI contract enables an investor to access the profits of a $50,000 share portfolio for a refundable deposit of $3,500.It is possible to earn profits from futures trading on either a rising or falling market.

What is a futures contract?
A futures contract is a legally binding agreement to buy or sell a stated and specified quantity of a commodity, financial instrument, or index at a fixed price sometime in the future.

By definition, a futures contract requires both a buyer and a seller. It makes no difference who comes first, so long as the contract is completed at, or prior to, the expiry date shown on the contract. A futures contract is bought when the trader believes the market will rise. The position is then closed-out by selling the contract within the same expiry period (3 months). If the contract is sold for a greater price than it was bought for, the result is profit.

Alternatively, a futures contract is sold when the trader believes the market will fall. And, as when buying, the position is closed-out by buying a contract within the same expiry period. The profit in futures trading is simply the difference between the selling and buying cost. It makes no difference if the contract is sold first and bought later.

It is this ability to profit from either a rising or falling market that is one of the major benefits of futures trading.
How much does it cost to buy a futures contract?
To purchase a SPI futures contract, you need a security deposit of $4,000. This deposit is known as the initial deposit. It is refundable at the end of your trade.

The initial deposit provides security against the greatest possible market movement that may occur within a 24 hour period. The $4,000 initial deposit is calculated from historical data, and may be increased or decreased by the SFE, according to market volatility. Additionally, you will need sufficient funds to cover daily variation margins.

What are the variation and margin calls?
A variation margin is the number of points the SPI gains or loses daily. At the close of each day’s trading, any profits (or losses) are credited (or debited) to your account. If your account balance can’t absorb the losses, you’ll be required to add funds to your account. This is known as a margin call. If funds aren’t forthcoming, your broker may close-out the position. This close-out enables the broker to recover any shortfall from the initial margin.
Who are futures brokers, and how can they help me?
To become accredited, futures brokers must first pass an examination set by the Sydney Futures Exchange (SFE). Following this, they then must gain experience with a member company of the SFE.

Futures brokers, like people, in any walk of life, range from the commission driven, to the genuine relationship builders. Obviously, all futures traders should aim to build a good relationship with this latter type of broker.

The normal brokerage fee for the sale and purchase of SPI contracts ranges from $25 to $50 for each transaction. However, some brokers do charge more. Before accepting this extra charge, you should carefully examine whether these fees are justified.

It’s natural for new traders to rely upon brokers for guidance. However, this usually leads to mediocre results - not because the broker is incompetent - but because the broker is unable to monitor trades as closely as an individual can.

Consequently, it is essential for each trader to make their own trading decisions, rather than rely on the broker’s advice (although your broker’s advice should always be sought and considered). This makes the trader - not the broker - responsible for the outcome of each trade.

How do I trade?
Placing a trade is as simple as picking up the telephone and asking your broker to buy or sell a contract. At the time the order is placed, the broker should be given a stop-loss order. This order will limit your losses if the market moves in the opposite direction to that which was initially anticipated.

A number of trading strategies require a position to be taken (subject to the predetermined criteria) and closed out at, or prior to, the close of trading. This is known as day trading. Day trading generally requires the market to be closely monitored throughout the day. This is best achieved via a live screen (expensive) or a pager (about $180 a month).

Another common trading strategy is to take a position and then hold it until certain predetermined criteria are met. Stops are used to protect the trade, and the position is closed-out when the exit criteria are met. This known as position trading. Position trading has two advantages. First, the market doesn’t need to be monitored continuously. And second, it allows the trader to engage in normal employment.

Do I buy or sell?
The greatest concern for most new traders is predicting market trends. There are two main methods used by traders to determine likely market direction: fundamental analysis and technical analysis.

Fundamental analysis involves the study of the basic economic factors that underlay market action. Shifts in interest rates, release of economic data, movements in the economic position of other countries, movements in commodity prices, and average P/E ratios of the underlying share market are just a sample of many factors that may influence price movements.

Technical analysis is the study of the reactions of traders to past events. This is usually achieved through the examination of chart action. Many technical analysis tools are available. These include: moving averages, Dow theory, Gann Theory, Elliot Wave theory, point and figure charts, candlesticks and oscillators.

How can I minimise risk?
Before you can earn consistent profits trading futures - without excessive risk - you need to learn as much as possible about the trading environment. Obviously this takes time, and an ongoing commitment and desire to learn the intricacies of the futures markets. For the novice trader, the first 6 to 12 months should be a cautious learning experience. While a small trading profit may be nice (most often probable), the sole objective should be to increase your knowledge and confidence about the futures markets.

Only once this confidence and understanding has been gained, should you increase the size of your trades - harness the power of leverage - and consequently, earn consistent profits trading futures.

How does a trading account operate?
The trading account (also known as the client agreement, or risk disclosure statement) must be opened with a futures broker before trading can commence. Most of the major share brokering firms have futures divisions. To place an order via a trading account, simply quote your individual trading account number to your broker, and then placed your trading instructions.

A written confirmation of the order will automatically be posted to you. Additionally, at the end of the month, you will receive a statement summarising your trades.
Do I have what it takes to become a successful trader?
A highly successful trader is both dedicated and professional. Additionally he or she will adopt (and follow) a specific trading strategy with unbending self-discipline. A successful trader will never perform a trade based on a subjective or emotional decision.

Below is a list compiled by the National Institute of Financial Studies that highlights characteristics common to all successful traders. A successful trader:

• Has eliminated the bias of fear and greed
• Trades objectively with firm self discipline
• Goes with the flow and trades with the trend
• Accepts the market is always right and cuts losses promptly
• Is unflustered and prepared for any market event
• Continues to learn
• Continuously maintains good money management techniques

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