The majority of successful projects begin with a solid blueprint. You should examine and research your objectives as well as all the factors that can affect your chances of success while creating a strategy.
That also applies to beginning a futures trading career. You must consider all facets of your approach while developing a futures trading plan, including your goals, skills, and risk tolerance. Your confidence in trading will grow as a result of going through that procedure.
Every trading strategy has essential components and actions that are necessary to help you achieve your goals. We’ll guide you through the key points to consider when developing a futures trading strategy that suits your needs in this post.
Pillars of Creating a Futures Prop Trading Plan
Establish Your Trading Objectives
It’s crucial to know exactly what you want to accomplish before you start trading futures. Selecting the right trading strategy will be made easier if you are aware of your goals, such as diversifying your portfolio holdings, hedging a position in a similar asset, or making predictions about market movements. Your time horizon—that is, whether this is a long-term or short-term trade—is a crucial consideration.
- Consider day trading if you would want to profit from intraday price swings. Your objective would be to make money by buying and selling several times during the trading day.
- Consider swing trading if you have longer time horizons and want to profit from market changes. Swing traders keep their holdings for a few days or weeks after making substantial purchases and sales of an asset.
- You may be a position trader if you have a much longer time horizon and plan to keep a position for several weeks or even months. There is more room for profit in position trading, but there is also more room for danger.
Before you begin, you may better describe your aims by providing answers to these fundamental questions. It will also enable you to recognize your trading style more clearly. Keep in mind that there is risk involved in any futures trading, regardless of your time horizon.
Fully Comprehend the Terms of the Contract
Expiration dates, trading hours, quantity per contract, tick size and tick value, margin requirements, and other important information are all included in the contract specifications. Before you execute your first transaction, it is imperative that you thoroughly go over these criteria and comprehend all of the risks and responsibilities involved.
Date of Last Trade:
Futures contracts, in contrast to equities, have an expiration date that must be met in order to take action on a position. The term “last trading date” (LTD) refers to this. A futures contract’s final trading day is the last trading day, which is often a few days before expiration. You have until this date to either close your position, roll over to the next month, or complete the conditions of the contract at settlement.
Many inexperienced traders find themselves in situations that might lead to unanticipated losses because they fail to remember the latest trading date.
If you keep onto a contract after it has expired and don’t take action before the final trading day, you may be legally obligated to settle it, which may involve an automatic liquidation of your position.
Margin for Futures:
The contract specifications also contain information on the first margin needs. With futures contracts, opening a position necessitates the deposit of an initial margin amount by the trader.
As soon as your position is set, you have to keep a specific amount of money in your account—referred to as the maintenance margin—to cover any losses you could incur while holding the position. Usually, the maintenance margin ranges from 50% to 75% of the original margin.
In the event that your losses are above the maintenance margin threshold, your broker or futures prop firm may sell your account to pay the losses or you may receive a margin call requesting further deposits. Due to the high level of volatility in futures markets, large price fluctuations might go against your position, causing your losses to quickly surpass the margin amount and triggering a margin call.
Tick Size and Value:
A futures contract’s minimum price increment is known as its tick size, whereas each tick movement in the futures contract has a monetary value known as its tick value. The contract parameters for each product specify the tick size and tick value, which differ depending on the product and are determined by futures exchanges. While creating a trading plan, knowing the tick size and tick value of a futures product is essential. They can assist you in determining what size position you are financially able to embark on and indicate the possible profit (and losses) a position could suffer throughout daily market fluctuations.
Let’s examine the formulas used to determine tick size and tick value for the E-mini S&P 500 contract:
- Size of tick: 0.25.
- One tick is worth $12.50.
A trader purchasing ten contracts of the E-mini S&P 500 futures at a tick value of $12.50 would stand to gain or lose $125 for each tick fluctuation (10 contracts X $12.50). Should the E-mini S&P 500 futures exhibit daily fluctuations of about 50 ticks, the trader stands to win or lose as much as $6,250 every day ($125 for each tick movement multiplied by 50 ticks).
In summary, understanding the contract parameters of each futures product is essential before moving on to the next phase, which is creating a risk management plan.
Create a Plan for Risk Management
With the leverage that futures offer, you may control a sizable contract value with a comparatively little initial investment. High leverage does, however, carry a substantial danger of much larger profits and losses, which is why risk management is crucial.
Together with your risk tolerance, your risk management plan should take your willingness to invest cash into account. How you reduce your losses while allowing for gains in your futures position size is a critical component of your risk management plan. Before you enter a possible transaction, position sizing will assist you in ascertaining the contract quantity and dollar amount of the deal.
You can think about your risk tolerance in the way that the table below illustrates. Please take note that even deals with low and medium risk tolerance might carry a significant amount of risk.
| Low Risk | 1-2% of total portfolio |
| Medium Risk | 2-5% of total portfolio |
| High Risk | More than 5% of the total portfolio |
| Rash | More than 20% of the total portfolio |
Suppose you are okay with little risk and have a $50,000 portfolio. If the trade amount is equal to 1% of your portfolio value, you can risk up to $500 (1% of $50,000) on the transaction.
Your ideal position size may be determined once you’ve determined how much risk you’re prepared to take on each transaction.
Maximum Capital Risk / Specific Trade Risk = Optimal Position Size is the formula used to perform this calculation.
Assuming you are trading a contract with a $5 tick value, you would like to set your stop-loss 50 ticks away from the entry price. Assuming a 5% risk tolerance, you would do the following computation to get the ideal position size:
Calculating maximum capital risk (account size times risk tolerance) yields $500 from $50,000 × 1%.
Risk associated with the trade (stop loss in ticks x tick value): 50 × $5 = $250
The ideal position size is $500 ÷ $250 = 2 contracts (maximum capital ÷ trading risk).
These computations indicate that two contracts are the ideal position size for this strategy. Purchasing more than two contracts would push your risk beyond what you can tolerate.
Determine Entry and Exit Points
It’s critical to take emotion out of your trading strategy. If you don’t, you can end up with a conclusion that deviates from your overarching plans and costs a lot of money. For this reason, a crucial aspect of futures trading is developing and adhering to precise, predetermined entry and exit strategies.
Exit strategies are the collection of guidelines used by futures traders to end a deal, whereas entry strategies are the set of guidelines used by traders to choose when to initiate a trade.
- Finding a suitable market situation to purchase a futures contract at a predetermined price objective is part of an entry strategy for futures trading. Technical analysis, fundamental analysis, or a mix of the two may serve as the foundation for this.
- In contrast, an exit strategy determines when to conclude a transaction in order to reduce losses or capture gains. It may be based on pre-established price goals or risk management calculations.
An examination of the economy, the underlying asset’s industry, and the asset itself are examples of fundamental tactics. If you trade S&P 500 futures contracts, for instance, you may assess correlations with other assets, volatility levels, and leading economic indicators.
Reviewing S&P 500-related news and research can help you spot favorable circumstances that complement your plan and advise when it’s ideal to enter or leave a position.
Technical techniques use past price and volume data of an underlying asset to determine entry and exit strategies. To determine possible entry and exit positions, traders will search for patterns, trends, and levels of support and resistance. You may accomplish this manually by using the built-in drawing tools in your trading platform or by applying well-known technical indicators such as Fibonacci tools, Moving Averages, Bollinger Bands, and Relative Strength Index (RSI).
Maintain a Notebook for Trading
Keeping a trade log will help you assess your success and make necessary improvements to your trading approach.
You may keep track of your trades and note crucial details like entry and exit prices, stop loss thresholds, and transaction durations by keeping a diary. You can find patterns and trends in previous trades that may have contributed to success or loss and modify your strategy accordingly.
It may also be used as a reference tool for impending deals, assisting you in identifying chances to employ profitable tactics in comparable market circumstances.
You may also learn to control your emotions and uphold discipline by keeping a trade notebook.
Before, during, and after every trade, you may get insight into your psychological condition and prevent rash actions by keeping a journal of your thoughts and feelings.
Ultimately, a trade diary may serve as a useful instrument for self-reflection and responsibility. By accepting responsibility for your trades and evaluating your performance, you may get a deeper comprehension of your advantages and disadvantages. This will enable you to create a strategy that works and move closer to your objectives.
The Bottom Line
Creating a trading plan for futures trading is crucial for a number of reasons. First of all, it assists you in setting objectives that specify your trading style and risk tolerance. Second, a trading strategy provides you with clear guidelines for taking and losing positions, which might enable you to profit from market moves while lowering risk. Finally, you may tweak and perhaps increase your overall performance by using a futures trading strategy to help you measure your progress and assess the efficacy of your trade over time.
