When choose a specific Stock Market Futures contract to trade in, please be aware that each trading mechanism, (stock market, option or Futures) has to meet two requirements: volatility and liquidity. Liquidity which is also known as volume will allow you to get in and out of trades. The higher the volume that easier it is. You can build a profitable position in a thinly trade futures contract only to get caught at the exit and take a hit from slippage. When we speak of volatility we are referring to the movement up or down in the stock market futures contract.
The greater the volatility the more opportunities there will be to trade. You may find the some stocks in the market are hard to trade due to low volatility; they will stay in a narrow prince range box. These are beneficial for long term investments if they pay a dividend, but not for trading. Just because you have a strong opinion of the future direction of a stock market futures contract it must also have good movement and volume to get you out.
Trading Stock Market Futures can be daunting at first, I’m sure you can say that eight out of every ten futures trader has blown up their account at least once. The danger is not the actual futures market itself but the people who trade them. Stock Market Futures offer a great opportunity for profits, but the dangers are synonymous with the rewards. If you have a risk on or gambling type of personality the futures market makes it easy for you to shoot yourself in the leg. On the other side of that coin, if you are a disciplined trader and have good money management principles you need not fear.
Back in the day futures where known as commodities the stuff that hurt if you dropped it on your foot, like a bar of gold, barrel of oil or a bag of sugar. In recent years there has been an explosion of all types of stock market futures and other futures contracts. You can have indices futures, commodity futures and even currency futures all trading online.
A typical future is a contract to accept or deliver a certain portion of a quantity of a commodity by a certain date. This contract is binding on both sides (seller and Buyer). This differs in the options market as the buyer has the right but not the obligation to accept delivery. I f you purchase a call or put you can leave the trade any time you want. In stock market futures you do not have that luxury. If the market goes against your position you have to add funds to your margin or exit the trade for a loss. Futures have tighter restrictions that options but as such offer better price for traders.
When comparing stock market futures to plain jane stocks when you buy a stock you are a part own in that company. When you buy a futures contract you don’t own anything. The funds you pay for a stock go to the seller, but in a futures contract the money stays with the broker as a security, this ensure you will agree to the delivery when the contract is due. When buying and selling stocks you pay interest for the margin used (if any) for borrowing. In futures you can collect interest on your margin.
One of the benefits of stock market futures is the futures contract, which ever one it may be, always has a settlement date. There are some savvy traders who use the differences to predict reversals and capitalize on the opportunity. It’s very common for futures traders to close their positions on their contracts early settling for cash either at a loss or profit. The existence of a settlement date causes an action, either good or bad you need to do something. It’s not like the stock market where a deluded person can hold their stock for ten years as it approaches zero. This settlement date cause traders to act and does not allow one to be an eternal hoper.
Let’s illustrate a cash sale (stock purchase) to a Futures trade:
Since it’s February 14th when I’m writing this gold is now trading at 1721.40 an ounce. You as a trader do some research and theorize that it is likely to trade to 1807 an ounce in the next four weeks. With cash you can go to a gold bar dealer and buy a 100 ounce bar for $172,140.00 and if you’re right in a month you can sell it back at $180,700.00 making a five percent profit, not bad. Now let see the same example in the futures market.
One Gold futures contract covers 100oz of gold. With a current value of $172,140.00 after the CME decision to increase the cash required for each contract the margin requirement is $7,425.00 per contract. So what that means is you control $172,140.00 worth of gold with just $7,425.00. Again say you are fortunate enough to be correct in your analysis and gold rallies you will make roughly that same amount less commissions as if you had bought it for cash. Only now your percent profit is now 2005 as opposed to 5% due to your margin. Futures gain free up cash flow and amplify your gains.
Know your limit
Most traders, once they learn the mechanics of the stock market futures contract become delusional with greed. A novice trader decides to enter a position with only $8,000.00 thinking he or she will be able to triple their money in a matter of weeks, and if repeated with maybe one loss hell be on his way to insurmountable wealth. If it were that easy we’d all be wealthy by now. So what is it that keeps traders from making millions?
The trouble with Stock Market Futures and all futures is they don’t move in straight lines. Charts are littered with fake break-outs and reversal and flat ranges.
Just as easily as a market can move with you, it can move against you. If you take the examples above, a five percent decline in price will only result in a paper loss for the cash sale where as the futures contract you’d be wiped out of your trade. Even before that would occur you would get a dreaded “margin call” your broker saying if you don’t sell they’ll do it for you. If you have no reserves and used poor money management like bet it all … your broker has no problem liquidating your position.
Traders who don’t have sound money management and personal management skills will tend to over extend their reach, margin themselves out and get kicked out of their positions in the slights sway against them. Even if their long term analysis was correct the markets are up and down, shaky and rest in the psychology of the masses.
Don’t get me wrong, Stock Market Futures are a great vehicle to make money. It just takes real discipline and sound money management to do so. If you are new to trading do not be tempted to trade futures and test your theories and skills on slower moving stocks.