How to Build a Futures Trading Plan

Most successful endeavors start with the development of a good plan. The process of building a plan gives you an opportunity to analyze and study your goals, and to consider all the variables that could impact your chances of success.

When starting to trade futures, it’s no different. Creating a futures trading plan requires you to think about every aspect of your strategy from your motives to your capabilities to your risk tolerance. Going through that process will help give you the confidence you need to trade.

Every trading plan includes key elements and steps—each critical to supporting your objectives. In this article, we'll walk you through the major areas to focus on when creating a futures trading plan that works for you.

Please note that trading futures can involve risk, so you should carefully consider your knowledge level and financial situation before you trade.

1. Determine your trading goals

Before you start trading futures, it's important to have a clear idea of what you want to achieve. Knowing your objectives—like whether you are looking to hedge a position in a related asset, speculate on price movements, or want to diversify your portfolio holdings—will help you choose what kind of trading strategy to implement. One important factor to consider is your time horizon, meaning is this a long-term or short-term trade.

• If you’re interested in capitalizing on intraday price movements, then you may consider day trading, and your goal would be to turn profits by buying and selling multiple times throughout the trading day.
• If you’re looking to profit from price movements but have longer time horizons, then you may consider swing trading. Swing traders buy and sell large quantities of an asset and hold their positions for several days or weeks.
• If your time horizon is much longer, and you intend to hold a position for an extended period like weeks or even months, then you may be a position trader. Position trading has a greater potential for profit, but consequently, greater risk.

Answering these basic questions will help you define your goals before getting started. It will also help you better understand what kind of trader you are. Remember that all futures trading, regardless of your time horizon, involves risk.

Key details in the contract specifications include expiration dates, trading hours, quantity per contract, tick size and tick value, margin requirements, and more. It’s very important to study these specifications and fully understand the risks and obligations associated with them before you execute your first trade.

Last Trading Date

Unlike stocks, futures contracts have a specific date when you need to act on a position before it expires. This is called the last trading date (LTD). The last trading date, usually a few days before expiration, is the final day a futures contract can be traded. On or before this date, you will need to either rollover your position to another month, close your position, or fulfill the terms of the contract at settlement. 

Many novice traders don’t keep track of the last trading date and find themselves in a position that may result in unexpected losses. If you don’t act before the last trading date, and hold onto a contract past expiration, there could be legal obligations to settle the contract, which could include an automated liquidation of your position.

In general, E*TRADE does not permit physical delivery of commodities or digital assets and may liquidate a position before the last trading date or first notice date (FND).

Futures margin

Another detail that can be found in the contract specifications is the initial margin requirements. Futures contracts require traders to deposit an initial margin amount to open a position. Once your position is established, you must maintain a certain amount of money, known as the maintenance margin, in your account as long as you hold the position, in order to cover potential losses. Maintenance margin is typically 50%-75% of the initial margin.

If your losses exceed the maintenance margin amount you may receive a margin call to deposit additional funds, or your broker may liquidate your position to cover the losses. Because futures prices can be highly volatile, significant price movements could move against your position causing your losses to quickly exceed the margin amount, resulting in a margin call.

Tick size and tick value

A tick size is the minimum price increment that a futures contract can move up or down, whereas a tick value is the monetary value of each tick movement in the futures contract. Tick size and tick value vary by product, are set by futures exchanges, and are outlined in the contract specifications for each product. Understanding the tick size and tick value for a futures product is vital information to have when establishing a trading plan. They reveal the potential profit (and losses) a position could incur during daily market movements and can help you determine what size position you’re financially able to take on.

Let’s take a look at how tick size and tick value are calculated for the E-mini S&P 500 contract:

• Tick size: 0.25
• Value of 1 Tick: $12.50

With a tick value of $12.50, if a trader buys 10 contracts of the E-mini S&P 500 futures, they would be looking at a profit or loss of $125 for every one-tick movement (10 contracts X $12.50). If the E-mini S&P 500 futures fluctuates on average around 50 ticks a day, that means the trader could lose or gain up to $6,250 a day ($125 for every one-tick movement X 50 ticks). 

Bottom line is that knowing the contract specifications on each futures product is a prerequisite for the next step, developing a risk management strategy.

Futures provide leverage, meaning you can control a large contract value with a relatively small amount of capital. However, with high leverage comes the potential for significantly higher gains and losses, which is why it’s important to carefully manage risk.

Your risk management strategy should consider the amount of capital you’re willing to invest alongside your risk tolerance. A key part of your risk management strategy is your futures position size—the way you minimize your losses while allowing for gains. Position sizing will help you determine the contract quantity and dollar amount of a potential trade before entering it.

The below table provides an example of how you can consider your risk tolerance. Note that the following descriptions are relative, and even low and medium risk tolerance trades may involve substantial risk.

Example

Let’s say you have a $50,000 portfolio and are comfortable with low risk. Applying 1% of your portfolio value to the trade amount means you can risk up to $500 (1% of $50,000) on the trade.

Once you know the amount you’re willing to risk on each trade, you can then calculate your optimal position size. The formula for making this calculation is, Maximum Capital Risk / Specific Trade Risk = Optimal Position Size.

Suppose you’re trading a contract where the tick value is $5 and you want to place a stop-loss 50 ticks from the entry price. To determine the optimal position size, assuming a 5% risk tolerance, you would make the calculation as follows:

1. Maximum capital risk calculation (account size × risk tolerance): $50,000 × 1% = $500
2. Trade’s risk (stop loss in ticks × tick value): 50 × $5 = $250
3. Optimal position size (maximum capital ÷ trade risk): $500 ÷ $250 = 2 contracts

Based on these calculations, the optimal position size for this trade is 2 contracts. If you buy more than 2 contracts, you would increase your risk past a comfortable level.

The above example is hypothetical and meant to illustrate the importance of position sizing as it relates to risk management. It does not take into consideration margin maintenance requirements.

Once you know your risk tolerance and management strategy, you can apply them to the next step, defining your entry and exit strategies.

It’s important to remove the emotional component from your trading plan. If you don’t, you might make a decision that is not in line with your overall strategies and could lead to significant losses. This is why having clear, predefined entry and exit strategies, then sticking to them, is a critical part of futures trading.

Entry strategies refer to the set of rules that futures traders use to decide when to enter a trade, while exit strategies are the rules that traders use to close a trade.

• An entry strategy for futures trading involves identifying a favorable market condition to buy a futures contract at a set price target. This could be based on technical analysis, fundamental analysis, or a combination of both.
• An exit strategy, on the other hand, involves deciding when to close a trade to take profits or limit losses, and could be based on predetermined price targets or risk management calculations (see step 3).

Most traders use fundamental and technical strategies, or a combination of the two, to determine favorable price conditions before entering or exiting a position.

Fundamental strategies include analysis of the economy, the industry of the underlying asset, and the asset itself. For example, if you are trading S&P 500 futures contracts, you may evaluate leading economic indicators, volatility levels, and correlations with other assets. You might also review news and research related to the S&P 500 to identify favorable conditions that support your strategy and help you determine the best time to enter or exit a position.

Technical strategies are used to inform entry and exit strategies by analyzing historical price and volume data of an underlying asset. Traders will look for patterns, trends, and support/resistance levels to identify potential entry and exit points. You can do this manually by utilizing custom drawing tools within your trading platform or by leveraging popular technical studies like Moving Averages, Relative Strength Index (RSI), Bollinger Bands, Price Momentum Oscillator, Fibonacci tools, and more.

By combining these strategies and doing thorough analysis, you’ll be in a better position to make well-informed decisions on when to trade.

A trade journal is an important tool for you to evaluate your performance and potentially improve your trading strategy.

A journal allows you to track your trades and record important information such as entry and exit prices, stop loss levels, and trade duration. By analyzing past trades, you can identify patterns and trends that may have led to success or failures and adjust your approach accordingly.

It can also serve as a reference tool for upcoming trades, helping you spot opportunities to apply successful strategies in similar market conditions.

A trade journal can also help you manage your emotions and maintain discipline. By recording your thoughts and feelings before, during, and after each trade, you can gain insight into your psychological state and avoid making impulsive decisions.

Finally, a trade journal can be a valuable tool for accountability and self-reflection. By taking ownership of your trades and critiquing your performance you can develop a better understanding of your strengths and weaknesses, which can help you develop a realistic plan and make meaningful progress towards your goals.

Building a futures trading plan is important for several reasons. Firstly, it helps you establish goals that will define your risk tolerance and trading style. Secondly, a trading plan give you well-defined rules for entering and exiting positions that may help you take advantage of market movements while mitigating risk. Finally, a futures trading plan will help you track your progress and evaluate the effectiveness of your trading over time, which can help you refine and potentially improve your overall performance.