When the closing bell rings at 4 p.m. and the stock market calls it a day, some investors are still making money — in futures.
But trading in futures can be tricky. So CNBC has recruited Rich Ilczyszyn, CEO and founder of iiTRADER.com, and Anthony Grisanti, founder and president at GRZ Energy, to reveal 10 things you need to know to trade futures.
It's part of a new CNBC initiative, "Futures Now," a multi-platform media experience devoted to futures trading. In a 15 minute live program available only on CNBC.com on Tuesdays and Thursdays at 1 p.m. ET, two prominent futures traders will gather for a fast-paced roundtable discussion that will focus on how to trade the news of the day using futures. From gold to gas to the S&P 500 index, the "Futures Now" traders will teach you how to turn today's events into tomorrow's profits.
So watch for "Futures Now." To prep, read on for the top traders' tips.
Published 1 Oct. 2012
When it comes to trading futures, an understanding of leverage is very important, Ilczyszyn said.
"Leverage allows traders to make a large investment in a commodity using a comparatively small amount of capital," Ilczyszyn explained. "This is one of the great things about the futures market. You often have to commit no more than 10 percent of a futures contract's value in order to take a long or short position."
As an example, Ilczyszyn noted that to purchase a futures contract for 100 ounces of gold for $177,000 at an example market price of around $1,770.00 per ounce, a trader only needs to put down about $17,000.
Traders should be cautious when using leverage, though, Ilczyszyn warned.
"If an asset price increases, it can magnify your return," Ilczyszyn explained. "But if the asset goes the opposite direction and price decreases, you can lose more that you originally put up in margin."
Trading futures can be risky, Ilczyszyn said, as it's possible to lose more money than you put into your account.
In turn, Ilczyszyn recommends traders only trade with funds they can afford to lose, which is also known as "risk capital."
"You should not be trading futures with money reserved for necessities, such as housing, food, transportation." Ilczyszyn said. "Work with a seasoned broker to help you develop your risk profile and discuss what asset classes are right for you."
Want to know the key to winning trades?
In Ilczyszyn's opinion, it's discipline. Traders need to know when to get in and when to get out of a trade. In other words, have a game plan.
"That's what stop orders are all about; Formulating a plan on how much you are willing to lose and how much you are hoping to make," Ilczyszyn said. "By placing a stop order, you're taking the emotion out of the trade."
A stop order can be defined as an order to buy or sell at a specified price, which is used to limit losses and lock in gains.
To determine entry and exit points, Ilczyszyn said traders should ensure the exit point or "profit target" is further away from the entry point or stop order.
"Allow your trade to make more money than you can lose," Ilczyszyn said. "Most professional traders will tell you that you want to have at least a 2-to-1 risk-reward ratio."
When setting stops, Ilczyszyn recommends referencing key technical levels.
Ilczyszyn suggests traders set their sell stop below key technical support. Set the buy stop just above key technical resistance, he said.
"These levels represent prices at which your investment thesis might change," Ilczyszyn explained.
To illustrate his point, Ilczyszyn gave an example. If a trader buys a gold futures contract at $1,665, the price target on the upside is $1,785. A sell stop should be placed at just below key technical support of $1,600, he continued, for a stop loss specifically at $1,599.
So how does this trade make money?
"I'm risking one to potentially make two. So, on the upside I'm looking to take 120 bucks profit. On the downside, I'm risking $66," Ilczyszyn said. "So this game plan allows you to make more money than you can lose. So that's why stops matter — they allow you to succeed."
Stop! Learn to use trailing stops, that is, Grisanti said.
"If you have a trade using stop orders and the trade is going in your favor, move your stop order," Grisanti said, adding this technique works for both long and short trades. "If you are long and the market is going in your favor, you should raise your sell stop. If you are short and the market is going in your favor, you should lower your buy stop."
In turn, Grisanti said traders are better able to cut their losses and perhaps more importantly, lock in profits.
Being as futures contacts expire, Grianti noted that holders of futures positions will need to make a decision: Do they want to close out or extend their position to another expiration date?
If you decide to close a position, Grisanti said you can either sell the futures you own or purchase the futures you're short.
If you decide to stay in the trade, however, you need to extend your position beyond the expiration date of the futures you hold, which is also known as "rolling" a position. To do so, you close your position while opening a new position in a longer-dated contract. It is used to give one's trade more time to succeed.
Don't wait until the last day of a contract to roll your position, though, Grisanti said.
"Give yourself at least two weeks to formulate your strategy," Grisanti said. "This way, you can take stock of the market dynamics and not feel rushed as you manage your positions."
When "rolling" a position from a near-dated month to a longer-dated month, one might notice that the value of the longer-dated contract might be greater or less than the contract is closing. The difference in price is sometimes referred to as the "roll cost."
Gristanti said traders shouldn't be alarmed by "roll cost," though, calling it "perfectly normal." The "roll cost" is the expense of maintaining one's position in a later month. It can be due to changes in market conditions, storage costs, interest rates, dividends and other variables.
To be a successful trader, it probably doesn't help to be a contrarian because as the old saying goes, "the trend is your friend."
"If a market trend is higher or lower, don't try to step in and run counter to what is going on. Try to get in at key entry points and follow the trend," Grisanti said, adding that there are ups and downs in both up- or down-trading markets. "Rarely does something go straight up or down, so know where to get in and catch the trend."
So if a market is rising, Grisanti recommended traders don't "stand in front of a freight train" by trying to pick a top. On the same token, he doesn't recommend investors try to "catch a falling knife" by calling a bottom in a falling market.
For anyone interested in futures trading, Grisanti said it's important to understand that no one trader is right 100 percent of the time.
"It is hard to admit you are wrong, but I have seen traders hold positions that kept going against them all because they could not admit they were wrong," Grisanti said, admitting he's been guilty of this himself. "If the trade goes bad and hits your stop points to get out, then get out because only a moron puts more on."
Futures traders shouldn't chase the market, Grisanti said.
"If you are a technical trader and you have done your homework with defined entry and exit points, but the market starts moving away from that, don't chase it and pay up," Grisanti said. "On the flip side, don't sell it too low. If you know your points stick with them, let the market come to you."
If the market never does turn around, Grisanti recommends just moving into something else.