Chapter 16: How to Exit a Futures Contract?
We now come to the end of the trading process wherein we shall learn how to exit a futures contract.
The process of trading starts at the very moment a trader spots a trading opportunity and develops a view which can be either bullish or bearish and then as we discussed in detail, every step that a trader has to go through while trading in futures.
Closing a futures contract is the last step that we shall focus on in this chapter.
Step 7: Exiting a Futures Trade
To understand how to exit a futures contract , let us first understand the concept of positions in the futures market.
Once this is clear , the process of exiting a future contract will be much more simpler.
Positions in Futures Market
Positions refers to trades that are currently live for a trader. In the futures market, a trader can enter into two types of positions based on the view developed by the trader.
Both long and short positions have their own unique risks and rewards, and traders can use a variety of strategies to manage these positions and maximize their potential gains.
Long and Short positions indicate the biases of a trader, so what does opening and closing of positions mean?
I am sure every trader must have come across these jargons as they are commonly used in the futures market.
But what are traders referring to when they mention that they have open positions or they are closing their positions in the futures market?
Opening and Closing Positions in Futures Market
It can either result in a profit or a loss, depending on the price movements of the underlying asset and the trader’s ability to manage their position effectively.
Open positions are a common feature of the futures market, as traders often hold their positions for varying lengths of time in order to take advantage of market conditions and potential price movements.
A trader is said to have multiple open positions if the trades taken are in more than 1 future contract.
For instance, if they are long (i.e., they have bought) a futures contract, they will need to sell a futures contract the same contract , to close their position.
Conversely, if they are short (i.e., they have sold) a futures contract, they will need to buy a futures contract to close their position.
Positions can be closed by placing an order with a broker to take the opposite position, and the position will be closed when the trade is executed.
It’s worth noting that closing a position in the futures market can result in either a profit or a loss, depending on the difference between the price at which the position was opened and the price at which it was closed.
Closing a position is important because it allows traders to exit and limit their potential losses to protect their capital. It can also result in a profit if the price moves in their favor.
While its obvious when a trader has open a position in markets , its because a trading opportunity is spotted with an anticipation of making profits. But there can be multiple reasons to close a position by a trader.
Closing a Trade to Book Profits
A trader can close his open futures position anytime on or before expiry of that contract.
Hence if a trader opens a position and price moves in his favour significantly, he has a choice of exiting so that he can take profits home.
Closing a Trade to Book Losses
Similar to booking profits , a trader can close a position when his stop loss is hit. if the trade goes against the direction that he was anticipating, he can close the open position to block his drawdowns further anytime on or before expiry day of that futures contract.
Compulsory Closing of Trades on Expiry
On Expiry of a futures contract, all open positions in a particular futures contract has to be closed as the exchange has to make sure that for the buyer there is a seller matched. Hence, a trader has to close all open positions on expiry.
If a trader still wants to keep an open position since his view remains intact, then he has to close the current month’s position and rollover over his positions and open a new position in the next month or the far-month contracts available in the futures market.
Forcefully Closing a Trade (Margin Shortfall)
As traders, we all tend to avoid that dreadful phone call known as the Margin call from our brokers. When a trade goes against a trader , MTMs start getting negative and the broker deducts the traders margin account upto the amount of losses incurred by the trader.
If the losses exceed the margin amount deposited by the trader, the broker shall demand to top up the margin account in case the trader wants to keep his position open.
If the trader fails to deposit the margin amount on time , broker has the authority to close all open positions and recover the losses incurred by the trader from the deposited margin.
Completion of a Trade
A trader is said to have completed a trade post closing the trade. Closing of positions indicates the completion of all the 7 steps of the process of futures trading.
- Developing a view
- Setting up a trading plan
- Choosing the right financial instrument
- Tools for futures trading
- Selecting the right strategy
- Risk management
- Exiting or Closing a position
This process is the same and is repeated everytime a trader spots an opportunity in the futures market.
And with this, we conclude this Futures Trading guide.
After thoroughly reviewing this guide on futures trading, its should be clear that futures contracts are a valuable tool for hedging against market risks and for taking advantage of price movements.
Futures trading indeed offer many benefits compared to other financial instruments, such as high liquidity and the ability to leverage positions.
However, it is important to carefully consider the risks involved and have a solid understanding of the mechanics of futures trading before entering into any contracts and this guide is curated with an intent to cover every possible aspect of futures trading.
With a clear strategy and disciplined approach, futures trading can be a profitable addition to an investment portfolio.