Futures Basics

What are Futures and How Can You Begin Trading Them?

Futures trading is nothing new but with the rise in accessibility and growing interest in speculative trading such as cryptocurrency, many are venturing into other asset classes including futures. So what exactly are futures, and how can you trade them?

Futures trading involves buying and selling contracts for the delivery of a specific asset at a future date, at a predetermined price. These assets can be a variety of things such as a physical commodity, underlying assets of an index or currencies. The futures market is highly regulated and offers transparency and liquidity, which can help to reduce some of the risks associated with trading. Futures contracts are traded on organized exchanges and are subject to the rules and regulations of those exchanges, which can help further mitigate risks.

Unlike futures markets, cryptocurrency markets are decentralized and largely unregulated, which can lead to increased volatility and risks  such as significant price fluctuations, regulatory risks, security risks, and other factors. Depending on how they are employed, futures markets can provide investment diversification and stability to highly speculative swings utilizing high amounts of leverage.

It is important for any trader to thoroughly research and understand the risks involved in any type of trading, and to carefully consider their own goals, risk tolerance, and financial situation before investing in any asset.

Leverage and Margin

Leverage in trading refers to the use of borrowed funds (i.e., margin) to increase the potential returns of an investment. In other words, leverage allows a trader to control a larger position in an asset than they could with their own capital alone. A single futures contract controls an exceptional amount of the underlying asset and it is not expected that the trader fronts the total value. For example, a single gold contract is for 100 Troy ounces  or a single oil contract is 1,000 barrels. In order to be traded, the brokerage will require a deposit or margin at a fraction of the contracts true value. This margin requirement works as an insurance that the trader will be able to cover losses if the value moves against them. Each day a minimum amount of capital is needed to support any outstanding contracts that the trader may have, this is called maintenance margin.

If the value of the contract moves against the trader enough, they may not be able to cover the losses which will trigger a margin call. This requires the trader to deposit additional funds into their margin account to bring the account back up to the required maintenance level. Failure to do so will result in the broker liquidating your position and possible further punitive measures such as closing your account and collection of any amounts not covered by your margin. Make sure you know exactly how much the maintenance margin requirements are for each contract you’re trading and stay well funded to avoid margin calls even if you’re in a losing trade.

Contracts Expire

Futures contracts have a set expiration date, after which the contract ceases to exist. When a futures contract approaches its expiration date, traders who hold open positions in that contract must either close their positions or roll them over to the next contract with a later expiration date. Contract rollovers allow traders to maintain their exposure to the underlying asset without having to take physical delivery of the asset itself.

For personal accounts, brokerages will automatically assume non-delivery and liquidate any outstanding contracts prior to expiration. Nobody wants to deal with taking responsibility of accepting shipment of 5,000 bushels of wheat!

Futures contracts are often denoted by their symbol,  2 or 3 character followed by the month and year that the contract expires. For example, CL 4-23 is crude oil (CL) which expires in April (4) of the year 2023 (23). It is important to keep track of when a contract nears expiration and to roll over to the next contract to avoid unplanned liquidation or drastic volatility and low volume leading towards the expiration date. Most popular contracts operate with contracts which expire every 3 months.

Getting Started 

To start trading, you will need to get and become familiarized with a trading platform. A trading platform is software which allows you to visualize market data and submit orders from. I’d recommend  NinjaTrader which is a popular trading platform and brokerage designed for trading futures, forex, and equities. It provides advanced charting, market analysis, and order execution tools for traders of all levels, from beginners to advanced professionals. They offer their award winning desktop platform for free with access to both their web and mobile applications.

Within NinjaTrader they provide simulated or papertrading accounts which allows you to get familiarized with futures trading and develop your own strategies. Whenever you’re new to trading any asset class, I’d always suggest beginning on a simulated account to understand things such as market behavior and getting a feel for the gains/losses for each tick of price movement.

If you’re looking to start with a smaller account and don’t want to worry about high margin requirements, consider looking into mini futures contracts which operate as 1/100 of the underlying contract. Many of the most popular futures markets have these mini markets!


Automated Trading Systems

The Importance of Automated System Testing and Fallacies of Backtesting

Automated trading provides several unique benefits over traditional, discretionary trading. Some of the most notable are their ability to operate continuously, execute trades quickly and adhere to its trading logic without the emotion that humans have. Human emotion often becomes a hinderance to the ability to succeed at trading due to the fear of loss and greed clouding one’s ability to truly think logically. Of course, there is a lot of depth to human intuition and insights which are not easily emulated in a computer program however I feel that the benefits outweigh those specific limitations.

Developing an automated system has never been easier with tools such as BloodHound and NinjaTrader’s strategy builder. With these you don’t have to strictly rely on a programmer to begin building your system and testing to see how the system performs through historical backtests and live simulations on a paper trading account. The only limitation you have is time and your ability to come up with new ideas to test and build.

While building a system is easy, the biggest hurdle that most new system builders have is understanding the reality and expectations between backtesting (historical, simulated trading) and live trading. There are many best practices in system testing and optimization that are overlooked which will ultimately lead to loss and system failure with unanticipated performance.

Backtesting systems provide a tremendous amount of insight into how a system can perform but is not infallible due to how the backtest processes data and generates execution logs. This can often lead to misrepresentations of performance and expectations in live trading. Even the smallest discrepancies per trade can cause a ripple effect that can turn a system which once looked promising into one that causes significant risk and losses.

It’s imperative that thorough and practical testing is done to give confidence that there are no surprises when you let the program run autonomously. Let Lucrum Trading Systems help with that confidence by employing their years of system testing experience on your next project and schedule a consultation today.

There are many questions to ask yourself; Is your data accurate, do you have enough data, is your slippage factored in appropriately, if using limit orders do you account for possible unfilled orders, is your order management configured to not close or reverse orders which haven’t been filled, are the bar types used showing a hindsight bias, do you have sufficient cushion for intra-trade drawdowns, are the system parameters fit to your testing data, are there ample failsafe in place in the occurrence of specific market conditions, is the system running in a stable environment with redundancy in the event of power/data loss? The list goes on about possible oversights which can dramatically affect a system’s performance moving forward and add additional risk you may not have expected.

The transition between simulated testing and live trading is not one to be treated lightly and a significant amount of time should be invested into building confidence that a system will operate exactly how you intend it to without any surprises. Be sure to have your system analyzed to prevent significant losses before you turn it on.

Automated Trading Systems, Uncategorized

How Innate Human Behavior Limits Effectiveness of Trading System Development

Designing any form of automated trading system is filled with follies of basic human behavior. The ceaseless desire to identify patterns in otherwise abstract data to the lust for wealth all cloud the appropriate diligence in creating a system with a measurable and meaningful competitive advantage.

Systems are developed with the idea of an initial truth, or the basis of how the system can otherwise find a way to generate a favorable reward to the risk applied. Once the idea of the initial truth is established, the process of creating the system is underway. This process plants several inevitable debts which can lead into a sunk cost fallacy which causes one to forcibly look for favorable outcomes in system performance.

  • Your time into creating the system
  • Your money into developing the system
  • Your ego of seeing your system succeed

Once your trading system is created and ready to test, the first two debts are already in play – you want the system to test well or that time and money invested would have otherwise been wasted. If the initial test looks poor, you will innately attempt to find ways to make it look better rather than scrapping it altogether. This approach leads to curve fitting performance as the data is already known and therefore used to your advantage. Tweaking the system to validate yourself will produce a system destined for failure in the uncertainty of future price data.

If the initial performance is good, while a positive sign, can be just as detrimental. The reason for this is that the acceptance of success puts a lesser emphasis on testing the fragility of the system with the fear that the initial results were unreasonable or just lucky.

Any system developed needs to be put through the proper stress test before it should be run in a live setting. In order to do this, you need to know the proper way to test the system in a way that honors the logic and perceived edge, but also shield yourself from walking away if the system is proven invaluable. The latter can be a difficult thing to overcome depending on how much time, money and effort was put into its development.

Lucrum Trading Systems is capable of being the unbiased third party to shield the inherent bias of a system designer and perform the necessary tasks to give confidence to proceed into a live environment. Schedule a consultation today to see how Lucrum can assist you with your trading system.

Your time and effort were put into the development of your trading system and while the initial investment may be great, the potential loss is even greater if it is not properly tested for live trading with the complete uncertainty of the future.

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