Futures And How To Use Them

With energy, and oil prices in particular, being so much in the news over the last year or so it seems that a lot of people are interested in trading in the energy markets. What amazes me as I come into contact with these people through the Energy Trader Team and Energy Trade Alerts that oilprice.com offers, though, is how many of them wish to do so without using futures.

There are ways of doing that, of course. The leveraged ETFs DWTI (bearish) and UWTI (bullish) for U.S. oil along with DGAZ (bearish) and UGAZ (bullish) for U.S. natural gas can be used in a regular stock trading account and are great for playing multi-day trends in those markets, but they don't offer anything like the leverage obtainable through the futures market. For many, though, it is that leverage that scares them. They have been told that leveraged trades are dangerous, and futures especially so.

The thing is, though, if you use futures in a limited, somewhat controlled manner and understand how to control risk they can be no more dangerous than the stock market. The first thing to understand, as least as a newcomer to futures, is that they are best used for short term trading. I rarely run a futures position overnight, preferring to use them as day trading instruments, because they are traded when the official markets are closed, but after hours trading is extremely thin. That leads to some exaggerated moves overnight and at weekends and often bad fills for stop loss orders.

Those stop losses are essential to controlling risk if you are to trade futures. I generally trade the E-Mini WTI contracts (/QM), which move two and a half cents at a time, with each tick representing $12.50 profit or loss. My trades are usually set up with a stop loss around 8 ticks (20 cents on the price of WTI) away, minimizing losses to around $100 per contract. The margin requirement for the trade is $1,870 per contract, so I stand to lose just over 5 percent if the trade goes against me. Given that I never employ more than 20 percent of trading capital on any one trade that limits losses to around 1 percent of my account. Profit targets, on the other hand, are around twice that.

Of course, there is no risk control method that is perfect. Stop loss orders are executed at the next available price after your level trades, not necessarily at that price. That is why leaving trades with such orders attached overnight, when markets are thin, is generally not a good idea. In my experience, though, during market hours the vast majority of stop losses are executed at or one tick away from your level.

The other advantage of only day trading futures is that you avoid rolling over at the expiration of a contract. Most platforms do that automatically for you if you get to that situation, but I would still rather know with absolute certainty that I am in and out of a trade before the distortions that sometimes occur as contracts expire. Day trading does sometimes limit what you can do and how much you can make, but nearly 20 years in dealing rooms taught me that controlling risk and limiting losses is, over the long term, more important than attempting to maximize profit.

With that as a guiding principle, then, it is quite possible for retail traders to trade in the futures market without excessive risk. If you still feel that futures are too risky then by all means use the leveraged ETFs mentioned above, or for even less risk, their unleveraged equivalents. If you are completely new to energy markets then those unleveraged products are probably the best way to get a feel for the markets, but once past that stage futures need not be scary. Understanding and managing the risks involved make them the best way to trade intraday moves in energy products.