Futures 101 – Understanding Futures Markets

Introduction

Futures markets are often misunderstood.
They are frequently associated with speculation, leverage, and short-term trading. In reality, futures contracts were created as risk management tools and remain a critical part of the global financial system.

This page provides a structured introduction to futures markets — what they are, how they work, and why understanding their mechanics is essential before placing a single trade.

What Is a Futures Contract?

A futures contract is a standardized agreement to buy or sell an underlying asset at a specified price for delivery at a future date. These contracts are traded on regulated exchanges and cleared through a central clearinghouse.

Key characteristics:

  • standardized contract size

  • defined tick size and tick value

  • fixed expiration dates

  • centralized clearing

Unlike private agreements, futures contracts are exchange-traded, transparent, and backed by margin requirements.

Why Futures Exist

Futures markets exist primarily for risk transfer.

Producers, consumers, and institutions use futures to hedge price risk. For example:

  • a farmer locks in a selling price

  • an airline hedges fuel costs

  • an institution manages interest rate exposure

Speculators provide liquidity by taking the opposite side of hedgers’ trades. Without this liquidity, hedging would be inefficient or impossible.

Standardization and Exchanges

One of the most important features of futures markets is standardization.

Each contract specifies:

  • the underlying asset

  • contract size

  • minimum price fluctuation (tick size)

  • monetary value of each tick

  • expiration month

This standardization allows contracts to be traded freely and ensures all participants interact within the same framework.

Margin and Leverage

Futures trading involves margin, not full contract value.

Margin is a performance bond, not a down payment. It represents the minimum capital required to hold a position.

There are two main types:

  • Initial margin – required to open a position

  • Maintenance margin – minimum balance required to keep it open

Because margin represents only a fraction of the contract’s value, futures are inherently leveraged instruments. This leverage magnifies both gains and losses.

Risk management is therefore not optional — it is foundational.

Daily Settlement (Mark-to-Market)

Unlike many other instruments, futures are settled daily.

At the end of each trading day:

  • profits are credited

  • losses are debited

This process is known as mark-to-market. It ensures transparency and reduces counterparty risk but also means losses are realized immediately.

Tick Size and Tick Value

Every futures contract has:

  • a tick size (minimum price movement)

  • a tick value (monetary impact per tick)

For example:

  • a contract may move in increments of 0.25

  • each tick may be worth $12.50

Understanding tick value is critical for:

  • position sizing

  • stop placement

  • risk calculation

Ignoring this detail is one of the most common beginner mistakes.

Expiration and Rollover

Futures contracts have finite lifespans.

As expiration approaches:

  • liquidity shifts to the next contract

  • active traders typically roll over before expiration

Holding contracts into expiration can involve delivery or cash settlement, depending on the contract. Most retail traders avoid this by exiting or rolling positions early.

Trading Sessions and Liquidity

Most major futures trade nearly 24 hours a day, but liquidity is not constant.

Liquidity varies by:

  • trading session

  • market participants

  • contract month

Understanding when markets are active — and when they are not — helps traders avoid poor fills and unnecessary risk.

Types of Market Participants

Futures markets include:

  • hedgers managing real-world exposure

  • institutional traders managing portfolios

  • market makers providing liquidity

  • retail traders seeking opportunity

Each group behaves differently, influencing volatility, structure, and price behavior.

Risk Comes First

Futures trading is not inherently dangerous — misuse is.

Common risk factors include:

  • excessive leverage

  • lack of predefined risk limits

  • emotional decision-making

  • poor understanding of contract mechanics

Professional traders think in terms of:

  • maximum risk per trade

  • daily loss limits

  • long-term capital preservation

Survival comes before profit.

Key Takeaways

  • Futures are standardized, exchange-traded contracts

  • They exist primarily for risk transfer and price discovery

  • Margin creates leverage and requires discipline

  • Tick value and contract size matter

  • Risk management is foundational, not optional

Where to Go Next

To continue your learning:

  • History of Futures – how and why these markets developed

  • Risk Management Basics – protecting capital and managing drawdowns

  • Trading Psychology – decision-making under uncertainty

Important Disclaimer

The content on this website is provided for educational and informational purposes only and does not constitute financial or investment advice. Trading futures involves substantial risk and may result in loss.