Trading futures is an investment strategy employed by investors to hedge against or speculate on the future value of different types of assets, be it commodities, bonds, or stocks. When thinking of a suitable way to invest your hard-earned money, futures trading is certainly one option that must have come to your mind to consider.
However, for many investors, future trading in the stock exchange is still a mystery, so, primarily it’s best to understand the basics of investing in exchange-traded funds or stock exchanges. For some financial instruments, this might sound simple, but this isn’t the case when it comes to trading futures. With this in mind, here’s everything you need to know about the pros and cons of trading futures.
Pros Of Trading Futures
There are many reasons you should trade futures, and the most common ones are:
1. High Liquidity
Future trading, especially when it comes to indexes, currencies, and commodities, is highly liquid. This high liquidity, according to NinjaTrader, has resulted in narrow bid-ask spreads and simultaneously enables investors to enter and exit the market at whatever time they feel is most appropriate. And with the low transaction costs, this shouldn’t be an issue.
2. No Time Decay
Another advantage of trading futures is that your investment doesn’t suffer from time decay, which means the value of your assets starts to reduce as time passes. Time decay is usually affected by different factors, including time till expiration. As a result, your winning position is switched into a losing trade, or your profit margin gets reduced. But with futures trading, you enjoy peace of mind knowing that time decay isn’t an issue to worry you.
3. Simple Pricing
The pricing model of trading futures are relatively straightforward because they’re founded on a cost-of-carry model. This means the future prices are derived by summing up the asset’s spot price and cost of carrying. In contrast, the pricing of options is a lot more complicated because it’s based on the complex Black-Scholes Model. This model is extremely complicated for the average investor because it uses a number of inputs.
4. Low Fees
The cost of a trading futures contract is also relatively low and ranges between USD$0.25 to USD$1 for each contract. If you’re a day trader, this is great considering you’ll need to carry out several trades daily, which is necessary because the opening and closing prices of the futures market usually differ. You can also close and reopen your positions every day to safeguard yourself from sudden market volatility.
5. Safer Trading Practices
Trading futures are highly regulated by exchanges and clearinghouses to set an even trading platform for all investors. In addition, certain trading provisions are well laid out to help ensure trading futures are safe.
6. Low Barrier To Entry
Some markets are usually inaccessible to the average investor. Nonetheless, this isn’t the case with futures trading which is characterized by a low barrier to entry thanks to contract sizes being flexible. Examples of future contracts available to you include Micro E-Mini contracts, E-Mini contracts, and regular futures contracts. With these several options, you have the freedom to choose which futures contracts is suitable to you depending on the available budget.
Cons Of Trading Futures
Trading futures while profitable are also associated with certain risks, and this includes the following:
1. Leverage Issues
Many investors know that leverage is a double-edge sword because it might help you make substantial profits while at the same time it can also result in enormous losses. And with price fluctuation a major issue when trading, you need to be especially careful of your leverage. Otherwise, the slightest move against you might necessitate you to provide additional money to prevent your position from being closed by your broker and cover the maintenance margin.
2. No Control Over Future Events
Another drawback about futures trading is the lack of control over future events such as unforeseen weather conditions, natural disasters, political tension, to name a few. Moreover, due to these unwanted scenarios, the demand-supply equilibrium can be distorted. As a result, you might end up making losses, because you don’t have any control to prevent this from happening.
3. Expiration Dates
All futures contracts have an agreed-upon set expiration date. Therefore, your trade might eventually end up not being profitable even after correctly speculating the market movement if the trade expires before that point is reached. This makes the futures contract valueless, after all the time and effort was exerted.
Future trading is undoubtedly an excellent technique for diversifying your investment portfolio beyond ordinary bonds and traditional stocks. But while this concept promises a greater return on your investment, it’s still considered complicated. Because of this, you shouldn’t rush and invest in trading futures but instead, take time to learn about the expected pros and cons as having been outlined in this guide. This will help you gauge whether trading futures are a suitable investment for your needs.
This article is for information and educational purposes only and does not form a recommendation to invest or otherwise. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.