Futures

Futures: high risk and cold calculation

Futures are one of the most powerful tools in the financial market, allowing traders to profit from price fluctuations with relatively small initial investments. But behind the potential for high returns lie equally significant risks. Let’s break down how futures work, who uses them, and how to avoid the most common pitfalls.

What is a futures contract?

A futures contract is a commitment to buy or sell an asset at a predetermined price on a specific date in the future. Unlike stocks, futures don’t grant ownership of the actual asset (like a barrel of oil or a share of Apple) — they simply lock in the terms of the transaction.

Key features:

• Standardization — the exchange defines the contract’s terms, including expiration dates, volume, and specifications.
• Margin trading — to open a position, you only need to post collateral (known as margin), which allows you to use leverage.
• Obligation to execute — unlike options, futures contracts require the transaction to be carried out at expiration.

Who uses futures contracts?

1. Speculators

Their goal is to profit from price differences. Thanks to leverage, even small price movements can lead to significant gains — or equally significant losses.

Examples:

• A trader buys a futures contract for oil at \$80, expecting the price to rise.
• If the price rises to \$85, the trader takes profit.
• If it drops to \$75, the trader incurs a loss.

2. Hedgers

Companies use futures to hedge against price fluctuations.

Examples:

• An airline buys oil futures to lock in fuel costs and protect itself from potential losses if prices rise.
  
• A farmer sells wheat futures to secure a profitable price for their harvest in advance.
  

Why are futures so risky?

1. Leverage — a double-edged sword

• It allows for significant profits with relatively small capital.
• But losses are amplified too — you can lose more than your initial deposit.

2. Margin calls

If the market moves against your position, your broker may issue a margin call — requiring you to deposit additional funds. If you fail to do so, your position can be forcibly closed to limit further losses.

3. Time sensitivity

Futures have an expiration date — if the price doesn’t move as expected within that timeframe, you may have to close the contract at a loss or roll it over, which can incur additional costs.

How to trade futures with minimal risk?

1. Define your strategy
   • Short-term trading (scalping, intraday trading).
   • Medium-term positions (weeks to months).
   • Hedging (for businesses).
2. Use stop-loss orders
   Setting automatic exit points at a predetermined loss level helps protect you from catastrophic losses. It’s a key tool for risk management in futures trading.
3. Manage your leverage
   The higher the leverage, the higher the risk. Beginners should stick to conservative levels to avoid large losses from small market moves.
4. Watch liquidity
   Thin markets — like niche commodity futures — can make it harder to execute orders at desired prices, leading to slippage and increased trading costs.
5. Analyze the basis
   The difference between the futures price and the spot market price (the basis) can impact your returns. Understanding this relationship is key, especially for hedgers and arbitrage traders.

Conclusion

Futures are a professional-grade instrument that demands a deep understanding of the market and strict discipline. They offer the potential for substantial profits — but they don’t forgive mistakes. Before you start trading, make sure you understand how the contracts work, test your strategy on a demo account, and clearly define your risk tolerance.

The golden rule: Never risk more than you’re willing to lose.