Understanding Futures from Scratch: Trading Rules, Risks, and Practical Guide

Many people start with stock investing and gradually hear the word futures. Some say futures can make you get rich quickly, while others warn that futures carry extremely high risks. What exactly are futures? Why does the same tool have such different results in different hands?

The Essence of Futures: A Contract for Future Trading

Futures are essentially a contract—both parties agree to buy or sell a certain underlying asset at a predetermined price at a future date. This concept has existed for a long time.

Imagine you are a farmer. Last year, your crops had a bumper harvest but you couldn’t sell at a good price, and this year you’re worried about a poor harvest. Such price fluctuations pose catastrophic risks for farmers. So someone came up with a solution: sign a contract in advance, locking in the price regardless of whether next year is a bumper or a poor harvest. This is the earliest form of futures.

Modern futures are financial derivatives, and the underlying assets include not only agricultural products but also stock indices, foreign exchange, crude oil, precious metals, and more. A futures contract details all specifics: trading code, quantity, minimum price fluctuation, expiration date, settlement method, and other details.

Why Can Futures Leverage Small Capital for Big Gains: Margin Mechanism

The magic of futures lies in leverage. Suppose you want to trade a contract worth 1 million yuan; buying stocks requires full payment, but futures only require a margin of 5-10%—that is, 50,000 to 100,000 yuan. This is why futures are called “small capital for big positions.”

But this is also the most dangerous aspect of futures.

Leverage amplifies gains but also magnifies losses. If the contract price drops by 20%, your 50,000 yuan margin could be wiped out or even lead to owing money. That’s why many people turn pale at the mention of futures—they often haven’t set up proper stop-loss mechanisms.

What Trading Methods Do Futures Use: Going Long and Going Short

Futures are far more flexible than stocks because you can both go long and go short.

Going Long: Expect the price to rise, buy first, and sell later for profit. For example, if you expect oil prices to go up, buy crude oil futures; if you’re optimistic about the US stock market, buy S&P 500 futures.

Going Short: Expect the price to fall, sell first, and close the position when the price drops. For example, if you think the stock market will correct, you can sell stock index futures to hedge risk; or if you are bearish on a commodity, you can directly short its futures contract.

Short selling in the stock market is complicated (requires borrowing shares, paying borrowing fees, etc.), but futures make long and short positions equally simple, making futures an ideal hedging tool—you can hold stocks while shorting index futures to reduce risk.

Spot vs. Futures: What’s the Fundamental Difference?

Spot trading involves buying real, tangible assets—you buy 100 shares of Apple, and you truly own those 100 shares. Futures involve buying a contract—a promise.

Spot requires full payment; futures only require a margin. Spot has no expiration date; futures have a clear delivery date. This means futures traders must pay attention to when the contract expires and whether they need to roll over or close the position before expiration.

What Is the Risk System of Futures

Understanding the risks of futures is key.

Leverage amplifies risk: This is the core risk. In stocks, the worst case is losing your principal; in futures, you could owe money.

Margin calls: If losses reach a certain level, the exchange will require you to top up your margin. If you lack sufficient funds, the exchange has the right to forcibly close your position, which could result in maximum losses.

Unlimited risk exposure: Futures prices can fluctuate extremely. The real value of a contract could be 20 times or more the margin; sudden price surges or drops can cause huge losses.

Requires discipline: Futures have expiration dates, which means even if your long-term prediction is correct, short-term reversals can force liquidation.

How to Participate in Futures Trading: A Seven-Step Beginner’s Guide

Step 1: Build Basic Knowledge
Futures have expiration dates, require only margin, involve leverage, and allow both long and short positions. These features determine their trading rhythm and risk profile.

Step 2: Determine Your Trading Style
Are you suited for long-term or short-term trading? Long-term investors using futures as their main tool is a recipe for disaster; futures are better used as hedging tools. Short-term traders can fully utilize futures’ liquidity and flexibility.

Step 3: Open an Account with a Futures Broker
There are many futures exchanges worldwide—Chicago Mercantile Exchange, New York Mercantile Exchange, Singapore Exchange, etc. Usually, retail investors place orders through a futures broker (brokerage firm), which connects to the exchange and clearinghouse.

Choose a broker based on: a wide range of trading products, fast and accurate quotes, low commissions, and security.

Step 4: Test Strategies with a Demo Account
Most trading platforms offer demo accounts. Before risking real money, repeatedly test your trading strategies with virtual funds to see if they are profitable. Skipping this step is basically gambling.

Step 5: Select Contracts to Trade
Futures products mainly fall into six categories: stock indices, exchange rates, interest rates, precious metals, energy, and agricultural products. Each has multiple contracts; understand contract specifications, expiration dates, margin requirements.

Beginners should start with mainstream contracts—such as S&P 500 or Dow Jones, which have the best liquidity.

Step 6: Deposit Funds and Start Trading
Each contract has different margin requirements. Check the minimum margin for each contract on your platform, then deposit the corresponding funds.

Step 7: Follow Your Trading Plan Strictly
Set stop-loss and take-profit points, then stick to them. Do not change your plan because of short-term reversals, and do not let losses grow out of control with a “wait and see” attitude. The leverage characteristic of futures makes discipline a matter of life and death.

Advantages and Limitations of Futures Trading

Advantages:

• Leverage maximizes capital efficiency, allowing small funds to control large positions
• Both long and short operations are possible, not limited to one direction
• Can hedge existing positions flexibly
• International futures markets are highly liquid, with small bid-ask spreads and high transparency

Limitations and Risks:

• Leverage is a double-edged sword; gains and losses are amplified
• Futures require higher professional knowledge; not seamless for stock investors to switch to
• Contract specifications are fixed and standardized, less flexible than stocks
• Must face expiration issues, requiring advance planning

Contract for Difference (CFD)(: A Flexible Alternative to Futures

If the fixed contract specifications of futures limit you, consider CFD).

CFD is an agreement between buyer and seller to track the spot price, settling gains and losses via price difference. Compared to futures, CFDs have several advantages:

More diverse products: Not limited by exchange contracts, with hundreds of tradable assets including stocks, forex, cryptocurrencies, etc.

More flexible: In theory, no delivery date; can be held indefinitely; trading volume can be chosen freely (e.g., from 0.01 to 30 lots); leverage can be adjusted.

Lower costs: Lower margin requirements, more flexible leverage, and lower entry barriers than futures.

But the risks of CFDs are essentially the same as futures—leverage can magnify losses, and unlimited losses are possible. So whether trading futures or CFDs, controlling leverage and setting comprehensive stop-loss mechanisms are essential.

Final Advice

What is futures? It is a tool. Like a kitchen knife, it can be used to cook delicious meals or cause harm. The key lies in the user.

Those who get rich through futures are often not because they predict accurately, but because they manage risks well—setting reasonable leverage, strictly executing stop-losses, and avoiding greed.

Those who blow up their accounts often underestimate risks, over-leverage, or treat futures as gambling rather than investing.

If you decide to participate in futures trading, start with a demo account, build your trading system, understand your risk limits, and then use small funds for real trading. Futures are not forbidden territory, but they must be respected.