Futures Trading - Balancing Risk and Reward



There is a paradox in futures trading; “get-rich" trading usually leads to poverty. While it is true there are many people that do get rich in futures trading, the norm is to lose. Because most investors don’t do the things necessary to be successful, they find failure is the only other alternative. This is a practice that requires training, experience and plenty of technical analysis; but then doesn’t all successful investing?

The Risks of Futures Trading

First, let’s back things up a bit; while futures trading can be very risky, the rewards can be very nice as well. Richard Dennis, a famed commodities trader, was able to parlay $1,600 of borrowed money into $200 million over ten years. While his results are truly extraordinary not everyone can expect the level of successful trading he achieved, there is good news for every investor; you can make money in futures trading. Now that we have made this statement, we can talk about futures trading.

Futures trading has a bad reputation as being filled with risk and, while there is risk, the truth is that futures trading is only as risky as a trader makes it. This is not the lottery or a trip to the casino; if you take a conservative approach, look for a reasonable return and make this a business, then the probability of success in commodity trading is very good.

What is Futures Trading?

Futures trading is different that investing in the stock market or bonds since you don’t actually own anything; in futures trading, you are speculating on the future direction of the price in the commodity you are trading. This is like a bet on future price direction. The terms "buy" and "sell" merely indicate the direction you expect future prices will take. He or she must only deposit sufficient capital with a brokerage firm to insure that he will be able to pay the losses if his trades lose money.

Futures trading is a sort of insurance plan for those who are trading and investing. A farmer may sell futures on his wheat crop if he thinks the price will go down before the harvest; conversely, a bread manufacturer may buy futures if they think the price of wheat is going to rise before the harvest. Regardless of the price movement, both are guaranteed their price. The final component of the equation is the investor in futures trading who looks for changes in the futures markets and seeks to gain advantages by buying or selling at a profit.

What are Futures Markets?

In addition to agriculture, there are a number of different futures markets. Among these markets are:

•Currency trading such as the US dollar, the British pound and the Japanese yen

•Interest rate futures on financial transactions and bonds

•Energy Futures on oil and gas

•Food sector on items such as coffee, sugar and orange juice

•Metals such as gold and silver

Each futures market has producers and consumers who need to hedge their risk from future price changes. The speculators, who do not actually deal in the physical commodities, are there to provide liquidity. This maintains an orderly market where price changes from one trade to the next are small.

Is Substantial Risk Inevitable in Futures Trading?

Minimizing risk in futures trading is easy; instead of taking delivery or making delivery, the speculator merely offsets his position at some time before the date set for future delivery. If price has moved in the right direction, he will profit. If not, he will lose. Greed and fear are the enemies of futures trading and the cause of most big losses.

Futures trading is not for everyone; it possesses risks that are limitless to an uninformed, undisciplined investor. With solid trading rules and an understanding of the markets and techniques required, futures trading can be a very rewarding endeavor.