Online futures trading: advantages and disadvantages
What is online futures trading?
A futures contract is an agreement to buy or sell a commodity at a future date. Everything about a futures contract is standardized except its price. All terms under which the commodity or financial instrument will be transferred are established before active trading begins, so neither party is hampered by ambiguity. The price of a futures contract is determined in the trading pit or electronic trading system of a futures exchange.
The Internet now allows access to these electronic commerce systems from anywhere in the world. This increases the liquidity in those markets and makes them even more attractive to traders.
Trading on all futures exchanges takes place in a context of legal regulation and rules established by each exchange and the Commodity Futures Trading Commission (CFTC). Regardless of whether your trade is executed within the trading pit or electronically, it is subject to the same rules, regulations and guarantees.
Advantages of online futures trading
To take advantage of. Futures trade on margin, which means that to take a position only a fraction of the total value must be available in cash in the trading account.
Commission costs. Electronically traded futures contracts do not require human intervention to match purchases and sales unlike a traditional futures pot. This means commission costs can be dramatically reduced, leading to significant savings for the frequent trader.
Liquidity. The involvement of speculators means that the futures contracts are reasonably liquid. However, liquidity depends on the actual contract being traded. Electronically traded contracts, such as e-minis, tend to be the most liquid, while pit-traded commodities, such as corn, orange juice, etc., are not as readily available to the retail trader and are more expensive to negotiate in terms of commission and spread.
Ability to go short. Futures contracts can be sold as easily as they can be bought, allowing a trader to profit from both falling and rising markets. There is no ‘rise rule’, for example, as there is with stocks.
No ‘decay time’. Options suffer from time decay because the closer they get to expiration, the less time there is for the option to go into the money. Futures contracts are not affected by this as they do not anticipate a particular strike price at expiration.
Automated trading. Electronic futures brokers offer programmers the ability to interact directly with their trading software. This means that custom written trading software can automatically trade a strategy without any human intervention. A system can generate buy/sell signals that are automatically routed to the trade along with stops and targets.
Almost instant fillings. With electronically traded futures, there is no need to call a broker and wait for the trading floor to fill up. Orders are instantly placed in the electronic order book and filled as soon as a match is found; for liquid contracts like the emini S&P500, this will be in a second.
Equal footing. With traditional pit-traded futures, the pit professional has a huge advantage over the retail trader in terms of speed of execution and costs. Electronic futures trading offers all participants exactly the same advantages.
Disadvantages of online futures trading
To take advantage of. It can be a disadvantage if you encourage trading with too high a risk for a particular strategy. A carefully designed money management plan is essential.
Overtrade. The instant nature of electronic futures trading coupled with low commission costs and tight spreads may encourage a trader to take trades beyond those determined by their trading plan.
Online futures trading offers significant benefits to the retail trader. However, a carefully developed business plan must be formulated before attempting to enter this extremely competitive business.