How to Invest in Futures
Most investors are familiar with asset classes like stocks or bonds; some might even have experience with trading options or currencies. But one area where many investors are lacking in knowledge and exposure in their portfolios is futures.
Even experienced investors may not have much exposure to the futures market. With large initial balances, sometimes $50,000 or more, opening a futures account is reserved for investors with significant resources. But there are other ways to play the futures market so you aren’t left out of the loop.
Trading futures for the novice
Investing in futures is much different from trading stocks or bonds. The risk is considerably higher due to a number of factors such as the use of leverage and mark-to-market accounting. Because of the risks, futures should only be used by investors with a high-risk tolerance.
The use of leverage in futures is ubiquitous. Investors might have some experience with leverage in their brokerage accounts with margin. These types of accounts let you borrow up to 50% which acts as a loan that gets paid back with interest. The goal is to make more on your investments than the interest that you have to pay, allowing you to boost returns. Of course, it also increases risk since losses are amplified, plus there’s the additional cost of the interest payment.
With futures though, leverage can be as high as 200:1. That gives you control over a large number of assets which can greatly boost returns, but it also means that your position can wipe out in a single trading day. One of the biggest differences investors see when trading futures compared to stocks is mark-to-market accounting. This means that positions are balanced out at the end of every day so a 1% drop in the value of a futures contract might be the equivalent of your whole position. And you won’t be able to simply rise out the correction even though in the long run your analysis could turn out to be correct.
Unless you have a large pool to draw from, investing directly in futures isn’t recommended. Instead, you could try getting exposure through asset classes like ETFs or mutual funds. For example, if you wanted to trade oil futures, you could invest in the United States Oil Fund ETF (USO). Using an ETF allows you to trade it like a stock even though the asset itself invests in oil futures.
Due to the risky nature of the futures market, most investors won’t ever directly trade them. But utilizing ETFs allow you to get exposure to markets you might not otherwise have access to. You can also use stocks to invest indirectly in futures. Mining stocks are heavily tied to commodity prices so investing in a mining stock will allow you to profit from price gains in the underlying commodity. If you want to trade futures, make sure you fully understand the risks before committing capital.