Why Trade Futures?

Most investors steer clear of the futures markets, and rightfully so… they are a completely different animal from investing in stocks and mutual funds.  However, as an asset class, there is no better way to diversify your portfolio than through trading futures.

Before I dive into why you may want to consider trading futures, I will give you the cons.

Futures trading does indeed involve significant risk and is not suitable for most investors.  The leverage that is inherent in trading futures can cause you to experience substantial losses in a very short period of time.

The futures markets are also the realm of some of the most sophisticated investors… hedge funds and commercial hedging operations.  These large trading businesses are known for hiring the best and brightest out of our universities to continue development of their already sophisticated trading strategies and systems.

Given that futures trading is a zero sum game, this means the competition in these markets can make it difficult for most people to profit.

Why Trade Futures?

With all that said, there are still some good reasons why some investors may want to at least look into these markets as a means of diversifying their investment portfolios, as a potential source of profits, and/or as a potential secondary source of income.

Keep in mind, trading futures is not for the individual who does not have the time to study and follow these markets on a daily basis.  Even if your intent is to invest with a trading advisor who will direct the trading in your account, you still need to do a significant amount of research for taking that step.

Diversification

As I mentioned, probably the best reason to trade futures is for the purposes of diversification.

During periods of economic imbalances, such as what we’ve experienced in 2020, the futures markets can provide profit opportunities when the stock and bond markets encounter difficulties.

So far in 2020, we’ve experienced a roller coaster ride that I can’t remember, and one that may be giving some investors some motion sickness.

As the fears of the Covid-19 pandemic took root in late winter, the stock market dropped over 35%.  The Federal Reserve then stepped in with massive liquidity, and voila, the Nasdaq Composite is actually 10% above the previous all-time high set in February.

The question is, what are the longer term consequences of the Fed intervention?  Another question is this… as I write this post we are at 10% unemployment and many small businesses, particularly restaurants, are closed for good… should the stock market be trading at these levels?

The futures markets offer an opportunity to exploit significant price moves in markets that are unrelated to the stock market… gold, silver, crude oil, etc.

With all of this Fed liquidity, the U.S. Dollar has declined sharply against other currencies.  Currency futures are among the favorite markets traded by hedge funds and Commodity Trading Advisors (CTAs).

As a result of the Dollar’s sharp decline in recent weeks, gold and silver have been on fire as fears of inflation permeate through the markets.

Notwithstanding these “flights to quality” when the stock market is vulnerable, the futures markets offer many other markets that are uncorrelated to stocks and bonds… particularly the agricultural markets.

Liquidity

As a means of diversifying your portfolio, the futures markets are also more liquid than other investments, such as real estate, precious metals, art, etc.

The most popular markets, such as the stock index futures, Treasury futures, crude oil and gold will trade hundreds of thousands, and even over a million contracts per day.

As a result, it is easy to enter and exit positions in most markets on a given day (some agricultural markets such as hogs and cattle are less liquid at times and you may not be able to enter or exit a position as desired).

Therefore, if you want to have a long exposure to Silver, you can buy a futures contract, and exit that position within seconds if you change your mind.  There is no way you can do that with the actual bullion.

Leverage

What attracts most small speculators to the futures markets is the leverage available in trading futures contracts.  In most futures markets, a deposit of earnest money (most often referred to as margin) of 10% or less of the total value of the contract is needed to place a trade.

For instance, if the price of December corn is trading at $4, and the futures contract controls 5,000 bushels, the futures contract controls $20,000 worth of corn.  At present, the initial margin required to trade one corn contract is about $1,000.  Therefore, you only need about 5% of the value of the contract to buy one contract.

This amount of leverage allows for the potential for substantial profit in a short period of time.

Of course, that leverage is a double edged sword, as you can also lose a lot of money in a short period of time.  In fact, while you may only need $1,000 to trade one contract, you are actually responsible for the ENTIRE value of the contract.

Therefore, you can easily lose your initial investment and THEN SOME when trading futures.

The reality is that professional and experienced traders typically will not use that much leverage when trading futures.

Unrealized gains

One particular feature I personally like most about trading futures is that the unrealized profits you have in a particular position may be used to add to that position, or initiate a position in another market.

This is a big difference from the stock market.  If your account is fully invested in stocks, your unrealized gains cannot be used to buy more stock… you must sell off an existing position in order to initiate a new position.

This is why it is possible to build your account more quickly in the futures markets than in trading stocks.

Again, however, this feature can be a double edged sword, as those unrealized profits can also disappear quickly if the market moves against you.

Final Thoughts

I decided to become registered as a CTA again because I fear that there will be some difficulties facing both stocks and real estate in the long term.

Over the last twenty years, we’ve experienced three significant economic crises, and the answer has always been to print more money, and add to our government debt.

That situation is simply unsustainable.

The futures markets offer diversification away from stocks, bonds and real estate so that you may be able to find profit when those markets run into difficulty.

Keep in mind, trading futures is like any specialized business.  There is a steep learning curve, and it is not a business that should be viewed as a get rich quick opportunity.

However, if you are serious and disciplined, these markets may provide the opportunity you are looking for.

I registered as a CTA to be in the position to provide advisory services for trading futures if indeed my fears are realized.

If you have any interest in learning more, feel free to contact me at Scott@scottcoleenterprises.com to discuss further.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES.