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Futures Strategy - Definition
Futures Strategies are ways to use futures contracts for the attainment of specific trading objectives.
Futures Strategy - Introduction
Futures strategies refers to specific ways of trading futures contracts in order to achieve a futures trader's trading objective. That objective can be as simple as to profit when the underlying asset goes up or down to as complex as using futures in order to perform hedging for a portfolio of assets or to reap an arbitrage profit. Futures strategies can also refer to a set of trading rules used in trading a specific futures strategy.
This tutorial shall explore in depth the different meaning of Futures Strategies.
Two Meaning of Futures Strategies
Futures strategy can mean two different things in futures trading; A futures strategy can be a specific futures trade or futures spread used for the achievement of a specific futures trading objective. A futures strategy can also refer to a set of rules or methodology that underlies the execution of the specific trade or futures spread, setting rules such as choosing of an entry point, a specific expiration month, a stop loss point etc.
When a futures trader go long on futures contract in order to speculate to upside or executes an intermarket spread in order to lock in the price difference between crude oil and gasoline, that futures trader is said to be executing a futures strategy. In the first case, it is a simple futures strategy (going long on futures contract) in order to profit on a bullish outlook and in the second case, it is a complex futures strategy in order to secure the price difference between two different assets. Each is a unique solution to an unique futures trading objective and each is referred to as a futures strategy.
A futures trader's specific criteria for the selection of trading candidates, entry point, stop loss etc in order to consistently profit from going long (or short) on futures contract is that futures trader's futures strategy for trading long / short futures contracts.
Futures Strategy as a Specific Trade
There are two main categories of futures strategies when referring to futures strategies as specific trades; Outright and Futures Spread.
Outright means going long or going short on a futures contract on its own in order to speculate to upside or downside. This is achieved simply by going long when the price of the underlying asset is expected to go upwards or going short when the price of the underlying asset is expected to go downwards. This is the most common way of trading futures with unlimited loss potential and no protection nor hedging. Going long on a futures contract is a futures strategy to profit from a bullish outlook and going short on the futures contract is a futures strategy to profit from a bearish outlook.
Futures spreads are futures strategies that employ futures contracts in combination with other futures contracts or instruments. Such combinations allow futures traders to profit not only from a bullish or bearish outlook but allow futures traders to achieve very precise investment objectives. Investment objectives such as locking in the price difference between two different commodities, reaping a risk-free arbitrage profit on futures contracts mispricing or even profiting from an expected seasonal change in futures contracts term structure, can be achieved using strategic futures spreads that are calculated to produce such a net effect. This is why each individual futures spreads are also known as futures strategies on their own as futures spreads are strategic use of futures contracts.
Futures Strategy as a Futures Trading Methodology
How does a futures trader decide which futures contract to trade, when to trade and how to trade them in an outright futures trade? How does a futures trader decide how to spot arbitrage opportunities for a futures arbitrage strategy? The specific methodology and rules used by these futures traders are also known as their futures strategies. Almost all futures traders have their own futures strategies. It is every futures traders' attempt at duplicable futures trading success. By setting and following a set of rules that have been proven profitable, futures traders trade according to these futures strategies in order to duplicate their success for long term futures trading profits.
Futures strategies as a futures trading methodology typically include specific rules for the following areas:
1. Candidate Selection: Specific rules, usually in the form of technical indicators, are set in order to find trading candidates that fit the profile of the specific futures strategy the rules are created for. For instance, candidate selection rules for a long futures strategy might include technical indicators showing bullish signals and screened for using a technical analysis or charting software. This ensures that only candidates that exactly fit the profit profile of a futures strategy is screened for and traded for consistent results.
2. Futures Selection: Once a candidate is selected, precise rules are usually created for picking the correct futures contracts and/or other instruments in order to create the exact specific futures strategy required. For instance, a bullish futures strategy might include rules for going long on futures contracts with no lesser than 3 months to expiration and a futures arbitrage strategy might include rules for the exact amount and expiration for all instruments involved in the arbitrage futures strategy structure.
3. Entry Conditions: Once the trade has been decided on, rules might also be included to govern the manner and timing in which the trade is to be entered upon. For instance, a bullish futures strategy might have entry condition rules governing the entry of a position only when the price of the futures contract remain bullish for one hour after market opens.
4. Stop Loss Policy: No futures strategies are foolproof. That is why all futures strategies will have rules governing when to bail out of a losing position in order to preserve capital for better, profitable, trades. This is especially important for outright futures trading due to the risk of margin calls. For instance, a bullish futures strategy might have a stop loss policy of selling out of a position when it makes more than 10% loss.
5. Profit Taking Policy: Knowing when to take profit is extremely important in futures trading especially for futures spreads which can reach their maximum profit potential within a short period of time making holding on to them for longer than that unnecessary.