Stock traders are always asking me why they should be interested in trading the Futures markets. “Aren’t Futures risky?” they ask. Well, yes and no.
Futures really aren’t more risky than stocks, in fact when you compare the volatility between the stock market and the Futures market; stocks can be much more volatile. However given the extreme leverage that trading Futures offers, bad traders don’t experience any longevity in the markets and therefore, on the surface, Futures can appear more risky than stocks. Futures trading, which deals specifically with the buying and selling of commodity Futures, by in large has received a bad rap. It seems that almost everybody knows somebody who has had a bad experience in the Futures markets. And with all the other investment vehicles clamouring for your attention, Futures trading normally ends up taking a back seat for the self directed investor, but this could be a mistake. Trading Futures offers opportunities not available in other markets. If you are serious about your investments, you owe it to yourself to at least check them out. There are at least 5 good reasons why you should consider trading the Futures markets.
1. Make money.
Well, this one’s pretty obvious isn’t it? The only reason to take an investment in the first place is in the hope of earning money with it. But while stock traders get excited about 10 – 20% returns on investment, Futures trading can measure returns in hundreds of percent. If the stock market was a race car, then the Futures market would be a rocket ship. Given the high degree of leverage the Futures market allows, your investment has the potential of earning tremendous rates of return.
For instance, a contract in the Gold market contains a 100 Troy ounces of gold. With gold currently trading at $390 per ounce this one contract is worth $39,000. However, unlike trading stocks, you do not need to put up $39,000 in cash in order to control the gold contract; rather you only need to deposit enough money to cover the margin. The margin for each commodity is determined by the exchange it trades on. Currently the margin for Gold is about $1300. This means that for a $1300 deposit you can control $39,000 in gold. Sounds pretty good, doesn’t it? But wait, it gets better. Let us say that you are expecting gold prices to rise to $400 an ounce from $390. Each dollar that gold increases is worth $100; therefore the $10 move would result in a profit of $1000 per contract. Given that your original investment was $1300, this represents an amazing return of 77% on your money! This extreme leverage of the commodity markets is a double edged sword however. For this reason proper money management is so important when trading Futures, since a $10 move against your position could have resulted in a $1000 loss.
2. Futures can not trade to zero.
Perhaps the scariest thing that can happen to a stock trader is that their stock will go bust. Remember Bre-X? Enron? One minute they’re flying high and the next they’re literally not worth the paper they are printed on. This can not happen in the Futures markets. The simple fact that a Futures contract represents a physical good, with real value, means that it is impossible that the price of the commodity will ever reach zero. This does not mean that prices can not go down however, simply that the commodity will never become totally worthless.
As long as there are people there will be commodity markets. People will continue to need goods like corn, wheat, soybeans, cattle, silver, gold, crude oil, natural gas, coffee, sugar, cocoa and the list goes on. The commodity markets have been referred to as the World’s supermarket. This analogy is not too far from the truth. This is where producers (ie. farmers) and buyers (ie. General Mills) get together to do their “shopping”. The speculator investor, that’s you and I, are the “grease” that makes the whole thing work and in return we can hopefully pick up a couple of dollars for our trouble.
Many stock traders try to lower the risk to their overall account by diversifying investments across various industries. This is a good strategy; however the problem with limiting your diversification to the stock market is that almost all stocks tend to move in the same direction, regardless of their sector. While there are always exceptions, generally speaking if the S&P index is climbing then almost all stocks appreciate and if the S&P is declining, then almost all stocks lose some of their value. While Futures are also somewhat affected by the state of the economy, by and large they follow their own cycle. Again, this is due to the fact that commodities represent physical goods. Corn, wheat, soybeans (just to name a few), grow at the same time every year and are harvested at the same time every year, regardless of what is happening to the stock market. This is the kind of diversification that is truly diverse and can add stability to your account.
4. Fewer markets to follow.
Recently I heard that there are over 40,000 different stocks available to the equities trader. The problem then becomes choosing the best markets to trade. It is humanly impossible to sift through 40,000 stocks in order to find the best opportunities. This is why equity traders use stock screening software to help them narrow down their search. By comparison there are only about 50 major commodity markets. Of these 50 you only need to choose about eight to ten markets to follow on a regular basis. Following just a handful of markets will offer you more trading opportunities than you can handle. I know of professional traders that make a living watching just three markets. The markets are diverse enough that there is something to suit almost every trader’s taste and budget. From the low margin, relatively “safe” markets like corn and wheat, to fast moving markets like soybeans, pork bellies and the e-mini S&P, commodity markets run the gamut.
5. You can use your current trading strategies.
Technical traders are always fond of saying “a chart is a chart is a chart”. This is their way of saying that it doesn’t matter if you are looking at an IBM chart or a chart for Live Hogs, you should be able to analyze them in the same fashion, and they’re right. Analyzing a chart of a Futures contract is no different than analyzing a stock chart. Futures analysis lends itself quite well to many of the favourite trading techniques in use today like Swing trading, Gann lines, Elliot waves, pennants, bull and bear flags, and my personal favourite, support and resistance trading. There are a couple of minor adjustments that have to be made when entering the world of commodity trading however, but none of them are major. The concept of trading on margin, which we touched on briefly, is one such adjustment. Another is the concept of selling short. While many equity traders shy away from short selling, it is prevalent in the commodity markets and can be a very profitable position to be in. Likewise the new commodity trader will want to learn a little bit about the seasonal tendencies of the markets they are interested in trading so that they can buy when demand is strongest and sell when it is weak.
While Futures trading certainly is not for everyone, I hope you can see that there are several good reasons why you might want to add the commodity markets to you list of investments. You never know, you may just find that you like what the Futures markets have to offer.
What do you REALLY need to improve your success as a trader?
Erich Senft has put together an exciting FREE mini-course entitled “5 Things Every Trader Should Know.” Discover the five things you must know about in order to improve yourself as a trader. Click here to learn more => 5 Things
For more from Erich, visit the Indicator Warehouse for additional futures resources and NinjaTrader Indicators.