Deciding Factors in Futures Contract Durations
If there is a particular reason why someone may want to enter into a longer contract, then there is generally the ability to do so, although this may not be in the best interests of those considering doing this.
Sometimes it might be though, or at least there may appear to be a good reason to enter into a longer contract. If someone has some special knowledge of the market, they may decide that the price of a contract down the road may be underpriced or overpriced.
For instance, if you feel that the stock market, or the value of whatever asset that the contract trades, will move significantly more or less than the market thinks it will over a year or two or whatever the time frame you are looking at, it can be to your advantage to go with the time frame that fits your outlook, as this may provide you with additional profit opportunities.
Given that futures contracts allow you to take either side of the trade, betting that the price is set either too high or too low as the case may be, this allows for all perceived price inefficiencies to be taken advantage of provided that they are significant enough to justify the bigger spreads that you tend to see with these longer contracts.
The Futures Market Already Prices a Lot of this In
For the most part though, as is the case with all financial markets, the current knowledge about what we know about the future movement of a security is already priced in. The current price is the sum of all knowledge about this basically, at least as far as what is generally known.
Some of this is based upon speculation of course, but in order to get a handle on how fundamentals, the things that affect the value of the underlying assets of futures contracts, will affect the market, you generally need a better understanding of the fundamentals than the market.
This is not easy to achieve, and requires more intimate knowledge of this than the market, and the market’s knowledge in this case is pretty substantial, given the volume of trades that are made by industry insiders, whose business it is to know where the physical assets they trade in are headed, and what will influence them.
If one is looking to trade longer term contracts for futures, to be able to have enough of a good idea that there are discrepancies in prices far down the road, you’re going to have to know more about the market of the asset than the major players in the industry, because that’s who you are going against with these longer time frame futures contracts.
Speculators really don’t get much involved in these time frames because the higher degree of uncertainty makes it a lot harder to get an advantage, even though there may be some advantages with them from a hedging perspective.
This is really why these longer term contracts exist, to provide the means to hedge over these longer time frames, and there’s generally no reason for futures traders to get too interested in these contracts, and futures traders generally work with much shorter timeframes than these provide, typically shorter than your typical 3 month contract.
Time Frames of Futures Contracts Follow Liquidity
The most actively traded futures contracts, by far, are the ones of a shorter duration, usually 3 months. Some of this is based upon business need, but most of the influence here is due to this being the desired time frame of futures traders.
If we look at the number of trades with a commodity for instance, and compare it to financial futures contract such as the S&P, we will see that the action with both occur mostly in these shorter-term contracts.
The fact that these contracts are more popular with market participants is what drives this, as the more liquidity that you have with a market, the easier it becomes to enter and exit positions, and the better the price you will get generally when you do so.
If there are less buyers and sellers in a market, there is less competition, and less competition means less favorable pricing, and more competition means better pricing with better spreads.
Once again, unless there is a special reason why someone wants to enter a longer term contract, due to a belief that it is significantly underpriced or overpriced, there’s no real reason to want to enter into these longer contracts.
Even if you want to stay in the market for a longer time frame than the contract, you can just roll over your position, closing the current one and entering a new one with the next contract. While there are transaction costs involved here in doing this, they really aren’t that significant generally.
Because the additional liquidity with standard length contracts makes trading easier and more price efficient, this is where most of the action in the futures markets occur, in contracts that are set to expire 3 months out or less from the time that the trades are placed.
Time Frames for Futures Traders
Even though the life cycle of a futures contract lasts 3 months, this does not mean that those who are looking to speculate on price changes of an asset traded in the futures market will stay in a trade for that length of time, or perhaps nothing even close to it.
Futures traders tend to rely primarily on technical analysis to time their entries and exits with their trades, and their time frame as far as how long they stay in a trade will depend primarily on the time scale of their charts.
If, for instance, you are using one day bars on your charts, this will require that you stay in trades for a fairly long period of time, several weeks typically, because it will take at least that long for your chart to generate entry and exit signals.
On the other end of the scale, you may be using one second bars, where your chart updates every second, and in this case it will generate buy and sell signals much faster of course.
Depending on the charting program you use, there will be a number of different time lengths that you can set your chart at, 1 second, 10 seconds, 30 seconds, 1 minute, 2 minutes, 3 minutes, 5 minutes, 10 minutes, 15 minutes, 30 minutes, 1 hour, 2 hours, 3 hours, 4 hours, a day, a week, and a month.
No one trades futures on a monthly chart though, as this is way too long of a range to trade positions lasting up to 3 months, but futures traders will select a variety of different time frames to analyze the price movements of futures contracts with.
As you might imagine, there’s far more to trading futures successfully than just deciding on a time frame to use on your charts, but this is the backbone of the process and is the most important deciding factor in determining the average length of time that a trader will be in a position.
It really all comes down to what you are looking to do, your skill set, your prior experience, and especially how much time you have to devote to your trading, as the shorter the time frame, the more closely managed your positions require, right up to never taking your eyes off the screen while in a position with the very short ones.
To sum up, as is the case with most markets, you want to be where the action really is as far as the volume goes, and more volume equals better trading efficiency, no matter what the objective is.