3 Levels of Futures Trading: Beginner, Intermediate and Advanced

In this interview, Doug Christie shares his 30 years of experience in futures trading and offers practical trading tips tailored for three levels of traders: beginners, intermediates, and advanced practitioners.

Hedder: What are some of the basic trading principles that a new trader should be aware of?

Doug: For someone that's looking to start trading in ag commodities, one of the first basics is just to understand how execution works in a market. So what kind of margins are required to trade in the commodity? How do you execute orders? What kind of daily price limits are in place and what increments are used to price a commodity? So there's really just some background homework that you need to go into.

It's a little different than in a stock market. So if you say, "I have $100 to invest in the stock market," it's pretty clear about how you might deploy that. The commodity market is where you will be talking about trading on a margin and where prices are denominated in dollars but across different units; so a bushel of soybeans, a pound of cotton, and how much a futures contract actually is.

Futures contract is not for a bushel of soybeans, it's for 5,000 bushels of soybeans. Understanding the units involved, the required margins, and how these factors translate into dollars and cents when executing orders constitute a fundamental level of understanding that is essential to grasp. That's the first thing I would say to a beginner.

Once you've grasped those mechanics of how you would trade in the market, then it's important that you develop your approach. How are you going to make a decision about price movements? How long a timeframe are you going to put on a price movement? So are you looking to get in and out of a strategy in the course of a day, or are you looking at a position that you might hold over a period of time? What's your time horizon for participating and executing in a market?

As a result of that, what kind of resources do you need to be able to withstand market volatility over that time horizon? Understanding execution fundamentals, getting an approach to the market, and then having a game plan about timing and size for entry and exiting market is really critical for someone who's looking to dip their toe into trading commodities.

Hedder: Moving on to the next level, what are the important things intermediate traders should watch out for?

Doug: For someone that's comfortable being in commodity markets and has some experienced trading, you might be looking at how you can ramp up your approach or become more active in trading. And in that case, traders should look at incorporating other inputs into your analysis.

For me, I start with a fundamental base. I like to understand supply and demand and physical flows of commodities as a basis for interpreting price. But then once that fundamental analysis and approach is in place, I then like to try to look at from a technical perspective, are there key market levels that might trigger additional buy or selling in the market? Are there momentum indicators about the pace of buying and selling in a market that might influence my position? So I think a more advanced trader is going to look at additional inputs and use those inputs to vary the sizing of their positions or to change the time horizon of their positions to have a maybe more complex approach to markets.

So maybe not such a simple buy and sell strategy, entry and exit, but looking at building up a position over time or scaling down a position over time, or looking at spreading a position across one time period versus another. So maybe more sophisticated approaches or more complex approaches than simply a single buy or sell trader.

Hedder: For advanced traders, would the strategy or approach be different?

Doug: As participation in markets grow you start to look at more advanced strategies. Typically, that involves having more complex construction of positions. So maybe more relative value trades versus absolute value trades, looking at using additional instruments. That means expressing a price view not just with futures, but with options, or using a combination of futures and options to express a price view. Typically, more advanced strategies entail more risk or more analysis.

If you've got a comfortable base in markets, you feel like you understand dynamics and you have an approach that you're comfortable relying on, then you can look at execution strategies that might be more complex or more risk oriented; that could be taking additional margin risk, adding options versus futures to add risk, or looking at more trades across multiple dimensions, multiple times, or multiple relative value trades. These are things that are maybe less transparent but add risk and add complexity, but still rely on the same basic approach.

Whether you're talking about futures or options, the fundamental standpoint still needs to be, "You need to have a price bias." And if you've got comfort around developing a price bias, you can execute that bias in a variety of more complex ways as you get more comfortable with execution and risk.

Hedder: Can you walk us through the psychological aspects of trading?

Doug: For anyone who's participating in a market, one of the things that's important and helps deal with volatility and even psychological concerns when you're trading in a market is having a game plan. That means knowing what you'll do if prices get to a certain level or you hit a certain level of profitability or a certain level of loss.

When you're watching a market and looking at a position move, knowing that you have a game plan that you're willing to execute is very helpful and comforting to that.

It's also very important that you have a scorecard or that you have a good way to keep track of what your position is doing. If you have a single long position or a single short position in the market, that's easy to keep track of and you can look at that scorecard pretty quickly.

If you have a more complex position, an options position, marking that to market becomes more difficult. So having the tools and techniques to be able to keep score in a real-time basis and know what your profitability or loss is, is important to being able to stay calm and stay focused in the market; that's really important. For me, I like to have that scorecard. I keep a P&L every day, I look at my P&L every day, and that can be a source of concern sometimes, but it's also just a discipline and a practice that helps you make something tangible. And when you couple that kind of scorecard with a game plan that says, "I said I would exit when I got to this level," and then executing that, being able to do that consistently and with discipline is really critical.

I will confess, and I'm sure many people would say the same thing – there are times when you deviate from the game plan or you make a short-term decision or you deviate from what you talked about. But I think just the fact that you had it there as a reference is critical. It's a checkpoint. You may consciously choose to go through it. You may consciously choose to exit before you got to a level that you were targeting. But the fact that it was there and you had a plan still helps bring focus and discipline and eliminate some of the noise that naturally comes up when you're trying to navigate a market.

When we look at analyzing markets or creating a game plan, as you get more sophisticated, that game plan or that scorecard needs to become more robust. So for more basic trades where you just have a single longer short position, you can put in target levels, you understand what the profitability implication of that is and so it's easier to create a game plan.

For a more advanced trader with a more complex constructed position, that game plan needs to rely more on kind of scenario planning or more scenario based analysis. So instead of just maybe keeping score marketing to market, you need to do some forward projecting looking at, "If prices go to this level, what will the impact on my position be? If volatility of an option goes to a certain level, what will the impact be on both my futures and my options position?"

I would say that as the positions become more complex, you need to go or transition from more of a scorecard to more of a scenario-based risk approach; i.e. what could happen. Setting some parameters, doing more modeling of positions to understand risk and reward, and develop an action plan around those scenarios so it becomes more interactive, more iterative than a simple buy and sell game plan that you might have if you have a less complex position.

Hedder: Basically what I'm hearing is that we should prepare in advance so you don't get caught by fear or panic if things take the wrong turn.

Doug: Yes. So I can speak maybe just a little bit to that. When we talk about a game plan, that game plan should include what you expect or hope to happen in terms of profitability, but also to envision what could happen in terms of loss. If you can set both those parameters, hopefully you're executing a game plan that's profitable and you're reaping the rewards of your analysis, but you should also be preparing for the possibility of losing.

If you had that in your game plan and ultimately you then lose as a result of it, you can execute. It may be a disappointment, but it shouldn't be a surprise. In other words, it's something that when you put on the trade, you should envision what could happen negatively. Again, this is something I've learned over a lot of experience and a lot of losses, is that we usually put on trades anticipating the good that's going to happen.

You think you understand a market and have a point of view about what's going to transpire, and you sometimes don't put the right attention into envisioning what could happen. But if you set parameters on both ends, then when that action happens, you can react. And it should give you some comfort, or at least if nothing else, manage your losses, preserve capital so that you can continue to act and execute the next day or the next week in a market.