Deepening Understanding of Futures: A Complete Guide from Zero Foundation to Risk Management

Many investors hear the word “futures” shortly after entering the capital markets. As a more complex financial instrument than stocks, futures can help savvy traders earn substantial profits, but they can also cause inexperienced operators to lose money quickly. So, what exactly are futures? Are they really as high-risk as rumors suggest? Today, we will systematically analyze the origins and mechanics of futures.

The Origin of Futures: From Agricultural Risks to Financial Innovation

The story begins in agricultural societies. When agriculture became the main mode of production, farmers faced a perennial problem: natural disasters and weather changes directly impact harvests. During bumper crops, grain prices plummet; during poor harvests, prices soar—these unpredictable price fluctuations expose farmers and merchants to significant risks.

Western merchants came up with a solution: why not lock in prices in advance? Both parties agree to trade at a predetermined price at a future date, thus avoiding the risk of price volatility. This innovative idea gradually evolved into the modern futures system.

The reason futures can leverage small amounts of capital to control large contracts lies in the margin system. For example, controlling a contract worth 100,000 yuan might only require a margin of 5,000-10,000 yuan. This leverage feature is both the charm and the risk of futures.

The Essence of Futures: A Financial Contract on the Future

Futures are essentially standardized contracts that specify that the trading parties must buy or sell a certain quantity of the underlying asset at a specific price on a future date.

The underlying assets of futures include:

• Commodities: crude oil, gold, silver, copper, etc.; agricultural products like wheat, corn, soybeans
• Financial assets: stock indices (S&P 500, NASDAQ, Hang Seng, etc.), exchange rates, interest rates, bonds
• Other assets: emerging assets like cryptocurrencies are also beginning to have futures products

Each futures contract clearly states:

• Underlying asset name and code
• Contract specifications (trading volume units)
• Minimum price fluctuation
• Trading hours
• Expiration date
• Delivery method (physical delivery or cash settlement)

Futures vs. Spot: Fundamental Differences in Investment Approaches

Novice investors often confuse futures with spot trading, but they differ fundamentally in several aspects.

Spot trading features immediate delivery: you buy tangible assets (such as stocks or commodities), pay the full amount upfront, and the goods belong to you once the transaction is complete.

Futures trading is contract-based: you buy or sell a price agreement rather than the physical asset itself. Only a margin (usually 5-10% of the contract value) is required to participate in a position much larger than your capital. Futures have a clear expiration date, after which you must close the position or deliver the asset.

This difference results in: spot trading requiring substantial capital, while futures allow small-scale participation; spot trading is simpler, whereas futures demand more precise risk management due to time limits and leverage.

Key Steps to Participate in Futures Trading

If you decide to enter the futures market, follow these steps:

Step 1: Build Basic Knowledge
Understand the core features of futures—expiration date, margin requirements, leverage, ability to go long or short. Your understanding guides subsequent actions.

Step 2: Assess Your Investment Style
Ask yourself: am I suited for long-term holding or frequent trading? Futures are often used for short-term trading or hedging, not long-term investing. If you are a value investor, futures may not be your main tool.

Step 3: Choose a Reputable Futures Broker
Global futures exchanges (CME, COMEX in the US, Singapore Exchange in Asia, etc.) facilitate trading through brokers. Selecting a reputable broker with accurate quotes and reasonable fees is crucial.

Step 4: Use Demo Accounts to Test Strategies
Most legitimate brokers offer simulated trading. Before risking real money, thoroughly test your strategies with virtual funds, familiarize yourself with the platform, and experience market volatility psychologically.

Step 5: Clarify Underlying Assets and Contract Specifications
Futures are traded across six major categories: index futures, currency futures, interest rate futures, metal futures, energy futures, and agricultural futures. Each has specific contract details—underlying asset, expiration date, price units—that you must understand.

Step 6: Deposit Funds and Set Risk Controls
After funding your account, avoid over-leveraging. Develop clear stop-loss and take-profit plans before trading and strictly adhere to them. This discipline is key to long-term survival in futures trading.

Step 7: Design Trading Strategies
Short-term traders tend to focus on the most liquid contracts (usually near-month futures) and combine technical and fundamental analysis to predict price movements. For stock futures, methods are similar to stock picking but focus on signals indicating buy or sell opportunities.

Two Main Approaches in Futures Trading: Going Long and Going Short

Futures are highly flexible because they allow profit from both rising and falling markets.

Going Long (Bullish): When you expect an asset’s price to rise, buy a futures contract first. When the price increases, sell the contract to realize gains.

• Example: Expect the Federal Reserve’s liquidity measures to boost the stock market, buy S&P 500 futures; expect geopolitical tensions to push oil prices higher, buy crude oil futures.

Going Short (Bearish): When you expect a decline, sell a futures contract first. When the price drops, buy it back at a lower price to close the position and profit from the difference.

• Example: Anticipate a recession causing stock prices to fall, sell index futures; expect commodities to enter a bear market, short relevant futures.

This dual-direction trading makes futures a hedge tool for professional investors. For instance, holding a stock but worried about a market downturn, one can short index futures to hedge systemic risk and lock in gains.

Advantages of Futures Investment: Why Professionals Favor It

1. Leverage Effect for Small Capital
Control large contracts with a small margin, making capital utilization highly efficient. Attractive for traders with limited funds but strong judgment.

2. Flexibility to Switch Between Long and Short
Unlike stock short selling, which requires borrowing and paying fees, futures can be shorted or bought long easily, adapting to different market conditions.

3. Efficient Hedging
Long-term investors can use futures for short-term hedging to mitigate market volatility and protect returns.

4. Sufficient Market Liquidity
Global futures markets have many participants, high daily trading volumes, small bid-ask spreads, facilitating large fund inflows and outflows.

Risks in Futures Investment: Critical Hazards to Know

1. Leverage Risks—A Double-Edged Sword
Leverage amplifies both gains and losses. A wrong judgment can wipe out your margin or even lead to owing money. Without strict stop-loss discipline, rapid losses and debt are common.

2. Unlimited Loss Potential
Unlike stocks, where the maximum loss is your invested capital, futures can incur losses exceeding your margin if prices move extremely against you. For example, during the 2020 oil price crash into negative territory, some investors faced margin calls and had to deposit huge sums to cover losses.

3. Time Risk—Expiration Pressure
Futures have fixed expiration dates. If your market view is delayed, you may be forced to close positions near expiry, locking in losses. Also, price differences between delivery months can be significant, and rolling over contracts incurs costs.

4. High Professional Requirement
Trading futures demands understanding contract details, calculating risk exposure, and precise timing—skills not easily mastered by beginners. Most market participants are institutions or professional traders; retail investors often face informational and skill disadvantages.

5. Fixed Contract Specifications Limit Flexibility
Futures are standardized: trading units, contract months, margin ratios are fixed. While micro or mini contracts exist, overall flexibility is limited.

CFD Contracts: An Alternative Balancing Risk and Flexibility

Between futures and spot trading, there is an intermediate option: Contracts for Difference (CFD).

CFD is an agreement between buyer and seller to track the price difference of an underlying asset. The key difference is: CFD has no expiration date; you can hold positions indefinitely without rollover issues.

Advantages of CFDs over Futures:

• Extensive Variety: Not only indices, forex, commodities, but also individual stocks, cryptocurrencies, offering broad choices.
• Flexible Trading Sizes: Minimum trade volumes and leverage can be adjusted, suitable for beginners.
• Lower Entry Barriers: Margin requirements are more flexible, with wider leverage options, and no strict exchange rules.
• No Delivery Pressure: No need to worry about contract expiration or frequent rollovers.

CFD Trading Focus:

1. Set Reasonable Leverage: Different assets have different volatility. Forex tends to be less volatile, so higher leverage is feasible; stocks and commodities are more volatile, so lower leverage is safer.

2. Complete Trading Plans: Whether CFD or futures, predefine entry points, stop-loss, and take-profit levels. Discipline in execution is more important than perfect predictions.

Summary: Who Should and Who Should Not Trade Futures

Suitable for investors who:

• Have extensive experience and risk awareness
• Can make quick decisions and strictly follow trading rules
• Have sufficient funds to withstand market fluctuations
• Use futures mainly for short-term trading or hedging, not long-term asset allocation

Less suitable for investors who:

• Lack experience or have low risk tolerance
• Are psychologically unstable or easily influenced by market swings
• Have limited capital and cannot bear leverage-induced losses
• Prefer long-term value investing strategies

Futures carry both risks and opportunities. The key is to understand thoroughly, develop rigorous risk management plans, and discipline oneself to control greed and fear—only then can one navigate the futures market steadily and sustainably.