Futures Trading Basics

Futures are standardized contracts to buy or sell an underlying asset at a set price on a specified future date. They trade on organized exchanges and are used by both hedgers and speculators. Because futures are highly leveraged, it is important to understand how they work before trading them.

This page explains futures contracts in plain language: what they are, how margin and leverage work, the difference between hedging and speculation, examples of major futures markets, and the main risks futures traders face.

What is a futures contract?

A futures contract is an agreement between two parties to buy or sell an underlying asset at a preset price on a future date. The contract itself is standardized by the exchange. It specifies:

• The underlying asset (for example, crude oil, gold, an equity index or a currency pair).
• The contract size (how much of the underlying each contract represents).
• The delivery month or expiration date.
• The minimum price movement (tick size) and tick value.
• The exchange on which it trades.

Most individual traders never take physical delivery of the underlying asset. They close their positions before expiry or roll them into a later month. The key point is that gains and losses are settled daily as the market price moves, a process known as marking to market.

Marking to market

At the end of each trading day, the exchange compares that day’s closing futures price to the previous day’s price. Profits and losses are credited or debited from each trader’s account. This daily settlement is part of what makes futures markets transparent and reduces default risk, but it also means losses must be covered as they occur.

Margin and leverage in futures

Futures are traded on margin. This means you put up only a fraction of the contract's value as collateral, called the initial margin. There is also a maintenance margin level you must keep in your account.

Because small price moves are applied to the full contract value, a relatively small upfront margin can control a large notional exposure. This is why futures are considered highly leveraged. Leverage amplifies both gains and losses.

Simple leverage example

Suppose an equity index futures contract represents $100,000 of notional value and requires $5,000 in initial margin.

• If the index moves up by 1%, the contract gains about $1,000.
• If it moves down by 1%, the contract loses about $1,000.

From a margin perspective, that 1% move in the index is a 20% move relative to the $5,000 margin. This is the power — and danger — of leverage.

If the market moves against you and your account falls below the maintenance margin, you will receive a margin call and must deposit additional funds or reduce your position. If you do not, your broker may close positions to bring your account back into compliance.

Hedgers vs. speculators

Participants in futures markets generally fall into two broad categories:

• Hedgers: businesses or investors who use futures to reduce risk from price changes in the underlying asset. For example, an airline might hedge fuel costs, or a farmer might hedge the price of a crop they will harvest later.
• Speculators: traders who take futures positions to profit from expected price movements, without any underlying business exposure to the commodity or index.

Both groups are important to the market. Hedgers provide a reason for the contracts to exist, while speculators provide liquidity by taking the other side of trades and helping prices adjust quickly to new information.

Examples of futures markets

Some of the most widely traded futures include:

• Equity index futures (such as contracts linked to major stock indices).
• Government bond futures, tied to sovereign debt markets.
• Crude oil, natural gas and other energy futures.
• Gold, silver and other metals futures.
• Grain, livestock and other agricultural futures.
• Currencies and interest-rate futures.

Each contract has its own specifications, tick size and trading hours, which traders must learn before participating. Many brokers provide detailed contract specs for each product they offer.

How futures differ from stocks and options

Futures share some similarities with other instruments you might know, but they also have important differences:

• Compared with stocks: futures are contracts on an underlying asset, not ownership of the asset itself. They use margin and daily settlement, rather than simply changing in price inside a brokerage account.
• Compared with options: futures create an obligation for both buyer and seller, while options confer a right to the buyer but an obligation only to the seller. Futures do not involve time decay in the same way as options, but they are still affected by time, interest rates and carrying costs.

Understanding these distinctions is important when deciding whether to use futures, options, or simpler instruments like mutual funds and ETFs.

Using futures for hedging

One of the original purposes of futures markets was to allow producers and consumers of commodities to reduce their price risk. Today, many institutional investors also use futures to hedge portfolios.

Examples of hedging with futures include:

• An equity investor using stock index futures to partially offset market downturns without selling individual holdings.
• A corporation with foreign-currency exposure using currency futures to lock in a rate.
• A producer or consumer of a commodity (such as an oil producer or food manufacturer) using futures to stabilize input costs or revenue.

Effective hedging requires careful sizing. A poorly sized hedge may leave too much risk unprotected or introduce new unintended exposures.

Using futures for speculation

Speculators trade futures to profit from anticipated price moves. They may:

• Take a long position if they expect prices to rise.
• Take a short position if they expect prices to fall.
• Trade spreads, such as differences between contract months or related markets.

Because of leverage and 24-hour trading in some contracts, futures speculation can be intense and fast-moving. Many traders use strict risk controls, such as maximum daily loss limits and predetermined stop levels, similar to the discipline needed for day trading.

Risks in futures trading

Futures are not suitable for every investor. Important risks include:

• Leverage risk: even small price moves can produce large percentage losses relative to margin.
• Gap risk: markets can jump on news, skipping over stop orders and causing larger-than-expected losses.
• Liquidity risk: some contracts trade thinly, making it harder or more expensive to enter or exit.
• Margin risk: adverse moves can trigger margin calls, forcing you to add capital or close positions at a bad time.
• Complexity: rollover mechanics, contract specs, and the impact of interest rates or storage costs can be confusing.

For beginners, it is often wise to learn futures concepts using educational resources and simulated (“paper”) accounts before committing real capital.

Futures in a broader investing strategy

Some experienced traders and institutions use futures to:

• Hedge equity portfolios against market downturns.
• Implement tactical views on interest rates or commodities.
• Gain exposure to broad markets with relatively low transaction costs.

For most long-term individual investors, however, futures are not a core tool. Simpler vehicles like mutual funds, diversified stock or bond holdings, and broad index funds may be more appropriate building blocks for retirement planning.

Getting started with futures (if you choose to)

If, after understanding the risks, you still want to explore futures trading:

1. Build your foundation first: ensure emergency savings and long-term investments are in place before committing money to leveraged products.
2. Learn the contract specs: understand tick size, tick value, margin requirements and trading hours for each futures contract you plan to trade.
3. Start small: use the smallest contract sizes or micro contracts where available, and limit position size relative to your account.
4. Use risk limits: set maximum loss levels per trade and per day, and respect them consistently.
5. Review results: keep a trading log and review your futures trades over time, just as you would with options or other active strategies.

Nothing here is personal advice. Always consider your own financial situation, goals and risk tolerance before trading futures or other leveraged instruments.

Futures trading FAQ

To see how futures compare with other instruments, you can also read about options, forex, bonds, day trading and mutual funds. For quick definitions of futures terms, visit our Dictionary Index.