Futures – Advantages and Disadvantages

Before I can tell you the advantages and disadvantages of trading futures, it’s important to understand how it differs from trading stocks.

When you buy a stock, you own part of the company. That is, you share ownership with other investors. That’s why we say you buy shares.

Trading futures, on the other hand, requires a contract to buy or sell the commodity in the future. That’s why they are called futures.

You can buy or sell those futures contracts as easily as trading stocks. For that matter, you don’t even have to lay out the money. However, you do tie up resources in the form of margin.

The problem is that the margin held is nowhere near the actual value of the commodity if you were to purchase it. This is known as the Notional Value. It’s calculated as the market value multiplied by the leverage.

Okay, I just threw you two more terms that need definition:

The market value is the price that traders are willing to pay. In general, this is determined by supply and demand. The leverage is the number of units of the future index.

For example, the E-Mini SP& 500 Futures has a leverage of 50. As of this writing it’s trading near a market value of 2100. Multiply that by the leverage (50) and you get $105,000. That’s the Notional Value of the E-Mini S&P.

As you can see, if you buy one E-Mini S&P contract, you are controlling $105,000 in value. However, unlike stocks, you don’t own it. You just have a contract to buy or sell it, depending if you went long or short.

Low Margin Required

What did you actually pay? That’s known as the margin that the broker requires you to hold while that trade is active. It varies, but it’s around $5,000.

If you bought a stock valued at $105,000 you’d have to pay $105,000. If you used margin, it would still require a payment of half of that. The advantage with futures is that you only tie up a small fraction.

However, the disadvantage is that you need to know what you’re doing. If you let a Futures trade get away from you, you are liable for a huge investment. Remember, it’s a contract.

That’s why traders buy and sell Futures contracts without actually ever buying the commodity.

What’s the disadvantage?

When trading futures you have to apply your due diligence in knowing the notional value of the future contract.

If you don’t pay attention to the Notional Value, and a trade keeps going against you and you don’t close the trade at a small loss, it can get out of hand.

You could end up losing a lot of money in a short time. If you reach the limits of your margin, your broker will close the trade if you don’t. That means you’ve been taken out of the market and you may not have the resources to get back in. Game over!

For this reason, you need to stay small. Don’t add to bad trades hoping to lower your cost bases. Rather, just admit that you were wrong and you’ll be around to play another day when an opportunity arises.

Advantages?

There are many, and these are the reasons why I love futures over stocks. The rest of this article will briefly list the advantages with trading futures.

Trading Long and Short

Going short with Futures is just as easy as going long. It’s just a matter of deciding in which direction you think the market is headed.

No Day Trading Limits

There is no day trading limit with Futures. Stocks can only be traded three times in a day before the IRS considers you a day trader. Futures can be bought and sold any number of times in a day, allowing one to take quick profits and benefit from intraday swings.

No Wash Sales Penalties

The IRS does not penalize you for taking a loss and reentering the same trade within 30 days. When this is done with stocks it is considered a wash sale and you lose the benefit of deducting the loss unless you can carry it forward to a future gain on the same stock.

The reason why it’s not penalized for Futures is because Futures pricing are recorded as Marked to Market. I won’t get into that here. You can always do a Google search for the term if interested.

Trading 24 hours

Futures trade nearly around the clock, except on weekends and short periods in between for exchange record keeping.

European Style Trading

Stock Options follow the American Style that can be exercised anytime. When trading stock options, one needs to be careful to avoid being exercised if the option is in the money.

Most Futures Options trade European Style, which can’t be exercised before expiration. There are some exceptions, especially with weeklies. That’s beyond the scope of this article though.

Tax Advantage

Futures and Options on Futures are treated according to IRS Section 1256. That provides a tax advantage since 60% of all gains are considered Long Term. This is true even if held for just a few seconds.

Learning to Trade Commodities

Many new traders ask how long it takes to learn to trade in commodities. It can take a couple of months for a diligent individual to learn to trade commodities. However, for those, who question about mastering trade commodities, they should know that it also may take a lifetime to trade commodities.

If you wish to make consistent profits from commodities trading, you will have to trade consistently. Never trade with the intention of making large sums of money right away. This is why usually 80% to 90% of the traders lose their money through trading commodities. When you are learning to trade commodities, a time will come when you achieve the breakeven point. This is the point where trading becomes profitable.

Commodity trading is held in commodity markets. It can be the derivatives market or even the spot market. In the derivatives market, commodities are traded via different financial instruments whereas in spot market, commodities are bought and sold hand to hand. Usually,Futures is a financial instrument that is used for trade exchanges in the commodity market.

Futures exchange is a standardized contract. It is set on the basis of particular futures exchanges. These include the size, the type, and quantity of the commodity along with the transaction price and the place where the commodity is to be delivered.

Some regulated Futures Exchanges negotiate the future contract. It is a place where the buying and selling orders are brought to a single place on the exchange.

A trading floor or trading computer is required for carrying out transaction in the commodity future market. This exchange takes place among the brokers, who are the members of the exchange of a particular commodity, which is to be traded. Both buyers and sellers are going to have a broker. They will transmit the purchase and sale order.

While you are learning to trade commodities, you see that the buyers and sellers of commodity futures contracts have certain obligations. The buyer has to take delivery and pay for the cash commodity. The time frame for the commodity contract is set. The seller has to deliver the commodity for which he has paid the price that was set for the exchange. The price can change on the quality of the material supplied. The obligations of the buyers and sellers can be eliminated by offsetting the trade exchange before the due date of the contract. This is usually how spectators trade in the commodity markets.

Just like every other type of trading, for commodity trading, you have to open a trading account with the commodity broker. Just choose the broker carefully when you are planning to take recommendations from the trader. Make sure that the trader provides a good trading commission along. The broker is going to be responsible for connecting buyers and sellers. Through the trading accounts, the trader can continue on the exchange himself too by using the computer. This method of trading has become quite preferable among the traders, as it is convenient and quick. Just contact a licensed broker for trading.

Commodity Market – An Ideal Platform for Capital Investment

A commodity market is a market where trades take place in primary rather than manufactured products. These products include soft commodities & hard commodities. Soft commodities include agriculture products like wheat, coffee, sugar along with various others. Hard commodities include gold, silver, oil etc. Unlike stock & share market, goods can be delivered physically in commodity trading as per investors’ needs & requirements. In India, there are many people, who are interested in investing in this market according to their custom needs & requirements; that too within their financial budget.

There are two main exchanges where commodity trading takes place by investors. One is MCX (Multi Commodity Exchange of India Ltd.) while another is NCDEX (National Commodity and Derivatives Exchange). MCX is an independent exchange of India, which was situated in Mumbai and established in 2003. In 2009, it was declared as the world’s sixth largest exchange, which were traded with commodity. It offers futures trading in bullion along with energy, ferrous & non-ferrous metals. And various agricultural commodities like wheat, potatoes, mentha oil, cardamom, palm oil etc. It has taken the third place amongst the global commodity bourses in terms of the number of future contracts traded in 2012.

Along with MCX, NCDEX (National Commodity and Derivatives Exchange) is another dominant online multi commodity exchange in India. It is a national level exchange which operations are managed by an independent board of directors and professional management. Moreover, it’s regulated by FMC (Forward Market Commission). NCDEX offers futures trading in 31 agriculture and non-agriculture commodities. It facilitates delivery of various commodities through a network of over 590 accredited warehouses through 8 warehouse service providers with storage capacity of around 1.5 million tonnes.

Although commodity market provides an ideal platform for capital investment for investors in India but at the same time, you can lose your hard-earned money if you do it without any proper guidance of a prominent commodity advisory firm. Your capital would be at a high risk if you don’t do investment in commodity market without getting any proper guidance of experienced financial advisor & analysts. For this, you should choose a prominent financial advisory, which has been providing affordable, accurate & beneficial services in India for many years. Accuracy & effectiveness of commodity tips provided by these institutions must be observed thoroughly by investors so that they could decide that their services are well suited for them or not. In this era, there are several sources available by which you can check accuracy of data of various commodity advisory firms and take your decisions to make an ideal investment.