The need to protect against volatile price movement in physical grain products in the mid – 1800 saw the advent of futures exchanges in the United States, not to mention that the Japanese in the east were already trading rice and silk futures preceding this period.However, the futures market has been long considered too complex and risky for the average investor, coupled with its negative reputation due to the lack of regulatory in its early development days. This perception on futures has faded recently, after more than 100 over years, as more and more fund managers find the stock index futures an excellent vehicle for controlling and managing their portfolio risk, affording it a status in par with other traditional investment vehicles such as stocks and bonds. While acting as a cost stabilizer for producers and end users, futures market also provide ample of opportunities to speculators who capitalize on the price difference.
Even though many consider trading futures riskier than stocks, I tend to differ. In fact, I would trade futures any time of the day as opposed to stocks. The reasons are plenty but I will discuss a few.
It mainly boils down to the perception of risk. In trading stocks, one has the liberty of time to decide whether to hold or close out a position as one is required to pay 100% of the stock value to begin with. This advantage of extended time often causes a novice trader to “hold and hope” when things are going against him, rather than acting decisively according to his original plans. Worst still, some may opt to further average a losing bet. If he doesn’t get lucky, he ends up ballooning the loss. As the loss grows bigger, total paralysis in decision making sets in the rest is history.
In the case of trading futures, time is decided by the contract expiry or the market volatility. The contract expiry can be anywhere from 1 month – 3 month, subject to the type of contract but one can be stopped out earlier by the trading house if price moves drastically against ones position. As your initial capital would normally be anywhere from 5% - 10% of the total value of the futures contract, your maximum loss will be limited to the initial margin in the event you are wrong about the market direction.
While the futures enable one to both long or short the markets, doubling the trading opportunity by rewarding superior % returns on a smaller capital as opposed to traditionally going long on the stock market, it must also remembered that more trading opportunity itself does not necessarily mean more profits. Trading futures can and will act as a double edged sword in the hands of an unruly trader. The key to success in trading futures lies simply in the ability to manage risk.
