Should You Invest in Futures?

Futures Risks and Rewards

Should You Invest in Futures?
February 13, 2014

Futures are investments that allow you to buy commodities by locking in a certain price and a specific time without actually buying the shares. These are speculative bets you are placing on the future price of a commodity, sometimes far in advance. In addition to commodities such as crude oil and corn, stocks, foreign currencies and Treasury bonds are also connected to futures and can be traded on various exchanges.

On the one hand, a distinct advantage of locking in a price for an extended period of time is to mitigate some of the volatility in a particular market. On the other hand, making short-term bets on an increase in price can yield massive returns. Because there are unlimited gains and unlimited losses, this type of investment is typically recommended for savvy and aggressive investors who have extremely high tolerance levels for risk. The types of investors who use futures generally include hedge funds, wealthy individual investors and institutions.

With futures contracts, you do not actually own the shares or the actual commodity. You don’t even put down the same amount as if you were purchasing the asset. What is most appealing about futures is the opportunity to gain from short-term shifts in the price of the commodity either based on the movement of the market, often hedging against significant losses in markets that tend to experience more volatility. Despite the risks that accompany futures, most experts are in agreement that they are a solid diversification tool in addition to, and with different characteristics than stocks and bonds. As a result, they are rapidly growing in popularity with individual investors.

If you are just getting your feet wet in futures markets, the first thing you will want to do is to open an account with a broker at a reputable trading firm. Select a futures market that is active easy to liquidate. You will then be required to put down a margin. While you can open an account at a brokerage with just a few thousand dollars, you will need to place a much larger chunk of cash into a futures trading account to cover any margin calls should the price of the commodity drop. This is needed to cover losses to maintain the minimum amount of funds required as part of your contract.

Individuals can trade their own accounts without a broker. This approach obviously increases the risk and requires constant care and attention to trends and predictions. A managed account allows your broker to leverage their expertise and trade on your behalf, reducing the amount of time, attention and some degree of risk for you. A third option is to select a commodity pool — that pools together a set of commodities. The benefits of commodity pools are similar to that of mutual funds in that they pool together funds from several investors, investing in several commodities. These also don’t require margin calls. However, the general risks that are inherent in other types of futures trading still exist with commodity pools.

If you are just beginning to learn about futures, why not do some paper trades first? Pretend to buy, hold and sell to see if you come out ahead in the game. This simulation may prevent you from losing lots of real money!

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