New To Futures Trading?
If you're new to futures trading there are a few things you'll need to understand before you're ready to trade.
There are also a lot of things you don't need to understand fully, however a basic knowledge is good!
You'll need to understand:
- The general concepts of futures contracts and futures trading
- What a U.S. Treasury 30-Year Bond is
- What a tick is
- How futures contracts are traded
- What it means to 'go long' and 'go short'
- What a margin requirement is
Futures Contracts and Futures Trading
Futures trading is a simple concept that has been around for a very long time. In fact the first futures market is believed
to have originated in Japan in the 1730s! In recent times the futures market has expanded greatly. The types of futures traded
today can make futures trading seem quite complicated but it's really not.
An example will help illustrate the main concepts. Suppose you own a factory that makes bread. The main ingredient you
purchase is flour. Let's say you've had a big order for some bread, to be delivered in three months' time.
It's for an important customer so you want to ensure nothing goes wrong! To have enough flour available when you need
it, you go to your supplier and ask for them to guarantee delivery of a certain amount of flour in three months' time. Your supplier
agrees and you settle on the price you'll pay for the flour in three months' time. You have just entered into a basic futures contract.
A more complete definition of a futures contract is: A standardized contract between two parties to buy or sell a specified asset of standardized quantity
and quality at a specified future date at a price agreed today (the futures price).
Hopefully now you get the basic idea of what a futures contract is. But where does the trading aspect come into it? Let's carry on with our example.
Suppose that after a month your customer cancels their bread order so now you no longer need the flour. Unfortunately you can't just cancel
the futures contract. You can, however, sell it. You contact another bread factory offering to sell them your futures contract. Luckily for you the
price of flour has gone up over the last month and is expected to rise more. This means you can sell your futures contract for a profit,
as it has the price of flour locked in at the price you originally agreed upon! You settle on a price and sell the contract. The other factory
now has the obligation to pay for and accept delivery of the flour when the future date is reached.
A futures day trader never wants to take physical delivery of an asset - they just buy and sell futures contracts, speculating on the future price.
They never hold any contracts at expiration.
The underlying asset of a futures contract does not need to be a traditional 'commodity'. For financial futures the underlying asset or
item can be a currency, security, financial instrument, or an intangible asset or referenced item, such as a stock index or interest rate. When
trading financial futures it is a cash market - nothing actually get delivered. At expiry you are either profitable or not.
The E-mini Bonds system involves trading financial futures. In particular the U.S. Treasury 30-Year Bond futures contracts.
U.S. Treasury 30-Year Bond
First of all, if you're not sure what a bond is then I suggest Investopedia's bond basics tutorial. You can access it here.
A U.S. Treasury Bond is a marketable, fixed interest U.S. government debt security. The treasury bond marketplace is deep and liquid.
It is traded by a wide range of users, including hedgers, speculators, bankers, bond dealers, mortgage servicers and portfolio managers.
The bonds are either traded in an 'open outcry' pit in Chicago, at the Chicago Mercantile Exchange (CME), or can be traded via CME's electronic
trading platform known as CME Globex.
The U.S. Treasury 30-Year Bond futures have the ticker symbol 'ZB'. The contracts expire in March, June, September and December each year. The
expiry date is built into the full symbol, so for example if you were trading the bonds future that expired in September 2010, the full symbol would
be 'ZB 09-10'.
The price of bond futures moves in Points. Each point for a bond future is worth $1,000. If, for example, you bought one contract at a price of
122 and sold it for 123, you will have made a point profit, so $1,000 (excluding commissions).
For more information on the U.S. Treasury 30-Year Bond futures consult the contract specification.
What is a Tick?
A Tick is the minimum price fluctuation that a futures contract can have. As mentioned above, the bond futures move in points, with each point
worth $1,000. To allow smaller changes in price, a point for the bond futures is divided up into 32 ticks. Because a point is worth $1,000,
it means each tick is worth $31.25 ($1,000 / 32).
The price of bond futures is expressed using the point and tick value. For example a price might be shown as 122'13, which means 122 points and 13 ticks,
so the equivalent of 122 and 13/32 points. When the 'tick' part of the price reaches 32, the point part rolls over to the next value, so 122'31 plus 1 tick = 123'00.
With each tick worth $31.25, a good income can be made by just trading for a few ticks. This is often referred to as tick trading. The idea is
to get in and out of trades quickly with a few ticks' profit. When I trade I'm looking to average two ticks' profit a day, which is about $60
per contract after commission. It does not sound like much, but if you are trading ten contracts, then it's about $600 per day.
To get an idea of what all this means it's best to look at a chart. The easiest way is to check out one of the videos on my blog.
You'll see how the price a bond future moves, and hear me talking about ticks a lot!
How Futures Contracts Are Traded
To trade futures contracts you need a futures trading account with a futures broker and a trading platform that will allow you to connect to
your broker to receive market data and place trades. When you place an order on your trading platform, the order is passed to the exchange
via your broker.
There are many futures brokers and trading platforms to choose from. If you would like
a recommendation for a futures broker send me an e-mail. E-mini Bonds recommends using
NinjaTrader as your trading platform.
Going Long and Going Short
We've all heard the classic stock market saying: "Buy low, sell high". Of course this refers to buying a stock when its price is low, and then selling
it at a later point when its price has increased, thus making a profit. In this situation you 'buy to open' a position, and then later on 'sell to close'
that position. The idea of buying something and then selling it later is very natural and easy to understand.
Suppose that you thought a stock would drop in price. How would you make a profit from that? Buying the stock is no good, as it will lose value
and you'll have to sell it later for less than you paid for it. What if you could borrow some stock? You could borrow some from a friend and sell it at
today's price. Once the stock drops in price you could buy some replacement stock for your friend. You would profit because the price you sold the stock
for was higher than the price you paid to buy the replacement stock.
The above plan sounds great, but where are you going to find a friend willing to lend you some stock? Well look no further than your broker! As long as
you meet your broker's margin requirements (see Margin Requirements section below) they will be willing to lend you some stock so you can sell it. You can then buy some back for your
broker at a later point so you're all square. In this situation you 'sell to open' a position, and then later on 'buy to close' that position.
So where does 'going long' and 'going short' come into it? The action described above where you borrow stock and sell it is known as 'shorting stock'.
If you 'sell to open' a position you are 'going short'. If you 'buy to open' a position you are 'going long'.
If you think the price of a stock will increase you want to 'go long'. You 'buy to open' a position and later on 'sell to close' that position.
If you think the price of a stock will fall you want to 'go short'. You 'sell to open' a position and later on 'buy to close' that position.
In the previous examples we talked about buying and selling stock. Futures traders, however, buy and sell contracts. This concept is a little
abstract as nothing physically changes hands. If you aren't really buying anything when you buy a contract, how much does a contract cost?
The answer may surprise you! When you day trade futures contracts your broker lets you buy and sell them in return for having a certain amount
of margin per contract. In other words a contract 'costs' the same amount no matter what the future price is. A margin is like a deposit to
cover the risk of the trade in case it moves against you. Most brokers have a margin requirement of between $500 and $1,000 per contract.
If the margin requirement is $1,000 and you have $10,000 in your account then you will be allowed to trade up to ten contracts.
Although brokers are very generous with their margin requirements, a prudent trader would allow a higher margin per contract. This is so you won't
blow out your trading account if you have a few trades go against you.