By Greg Coffey, Los Angeles USA.
I have heard many comments by traders and non-traders that trading futures is very risky. I believe those thoughts come from a mis-understanding or confusion about the leverage offered by the small margin requirements of futures.
For the S&P500 Index, the value of one ES (for e-mini Globex traded) futures contract is $50.00 times the point value of the ES contract. For example, if the contract is trading at 1400, then the value of one contract is 50 x 1400 or $70,000.00.
But, you are only required to have $4,000.00 in your account to put up as margin to own (or sell short) this contract. (This margin amount can vary with maket volatility and whether holding intraday or overnight, check your broker for their current margin requirement).
If the price moves just 8 points (about 1 day average move), the value of the contract changes by 8 x $50 or $400, which is 10% of the margin value. Now some people may use 100% of their account as margin, and if your account is greater than $25,000, there are special “daytraders” margins which are much smaller (again, see your broker),
so that is a large gain or loss in one day and that makes people nervous that you can wipe out your whole account in a few days if you lose several days in a row, or in commodities it could occur with just an overnight gap.
In reality, when you trade a contract, you are trading a cash value of $70,000 (or whatever the value is at $50/pt, or the point value of your particular contract). So, that same $400 move is EXACTLY the same as the same percentage move on $70,000 worth of any stock. There is NO difference in the Dollar value of risk if you keep that in mind.
Margin on futures allows a trader to “control” a much larger amount of cash value than they actually have in their account. That magnifies the trade results, win or lose, but the percentage change on the cash value equivalent is no different to that same cash value traded on a stock.
In favor of stocks, the owner of a stock can hold onto a losing position even if the stock goes down in price a long way, as long as the corporation doesn’t go bankrupt. The fact remains, the loss is still the total CASH value of the instrument traded.
It still comes down to how much are you prepared to risk losing on a trade in order to make a larger profit, and also how long you are prepared to wait for that profit. It would be a good idea if you are first starting out, to not keep any futures position open overnight to avoid those large overnight moves if they go against you.
Or you would need to be trading a long enough time frame that any overnight gap stopping you out, would be a smaller amount of money than what you were reasonably expecting to gain on the trade.
I recommend a trader try Futures ONLY if you are prepared to place an exit stop at the same time as you enter any Futures trade to limit your risk. Remember, whether trading stocks or Futures, if you take a short postion, there is no limit to how far the position can move against you - USE STOPS. Never allow the amount of margin required for any position you take to be a large part of your account. ALWAYS consider the cash value of your position.
Remember to roll your Futures contacts over to the next contract series up to a week before expiry (which means you need to sell any contracts about to expire, and replace them with contracts in the next monthly sequence).
I hope that gives you some confidence to try out these very flexible and rewarding trading instruments.