Last Updated on 11 September, 2023 by Samuelsson
Welcome to our article on the benefits of trading futures! In this piece, we will delve into the advantages of trading futures, how they differ from other financial instruments, and how traders can leverage their investments with futures. We will also explore how futures contracts offer risk management opportunities and the concept of price discovery in relation to futures trading. In addition, we will discuss how futures contracts facilitate portfolio diversification and the potential benefits of trading futures for hedgers. Finally, we will examine how futures contracts contribute to the efficient functioning of financial markets.
The main benefits of trading futures are:
1. Leverage – You can gain significant market exposure with little capital
2. Liquidity – The markets are very liquid
3. Diversity – You have easy access to a range of otherwise hard to access markets.
4. Short Selling – Going short with futures is as simple as going long.
5. Low Costs – Trading Fees with futures are very small in relation to the market exposure you get.
6. No Time Decay – With futures, you do not have to worry about time decay, as you do with options.
Benefits of Futures
Leverage can be risky, but used right it can also provide fantastic profit opportunities. Simply put, leverage means that you are taking a loan to size up your trade. In that way, you may hold positions worth several times your account balance, which enables you to profit from even the tiniest of price movements.
When trading futures, you trade with leverage. The cost of the contract, the initial margin, is the cost of entering the trade. This is how much money you need to have deposited in your account to be able to open a position. Once you have bought or sold short the contract, the initial margin is replaced with the maintenance margin. The maintenance margin is the amount that you need to have in your account for the position to remain open, and it is lower than the initial margin to ensure that you are not stopped out immediately after entering a trade.
The initial margin of a futures contract is often somewhere around 3%-12% of the futures contract value. This means that you may control 8 to 33 times more capital than you hold in your account, which is why it is important to be careful and calculate the risk correctly.
One way of calculating the risk is by using the point value of the futures contract, and measure the distance to your stop loss. That way you know exactly how much you are risking, and can position size accordingly.
For more information about futures and how they work, have a look at our article on futures.
If you feel insecure about position sizing, you may check out our article on the five best position sizing strategies. There we also cover how you correctly calculate the risk when trading futures.
Futures offer great liquidity compared to other securities like ETF:s, especially for certain markets like Crude Oil. Liquidity is paramount because it helps to reduce slippage, which has the potential to consume a large chunk of your profits.
Traders who backtest trading strategies can view the adverse effect of slippage on trading strategies. Sometimes you will find an edge or strategy that looks alright. However, once you add transactional costs of which slippage is one significant part, the trading strategy may no longer look as alluring.
With futures, you may trade more edges and strategies, because the liquidity is there to let you profit from smaller market inefficiencies. With other more illiquid securities, the liquidy may be too low which is especially noticeable during the night sessions, where some contracts, like the S&P 500 futures contract, still offers enough liquidity for trades to be executed without too much hassle.
Here is a list of the five most liquid futures market. Notice that the ES futures contract is number one. It is not impossible that it soon will lose its position to the up and rising micro e-mini futures contract (MES). The launch of the micro e-mini futures contracts became the most successful launch in the history of CME, and its smaller size may be enough to push it to the top.
- E-mini S&P- 500 ( ES )
- 10 Year T-Notes ( ZN )
- Crude Oil Futures ( CL )
- 5-Year T-notes Futures (ZF)
- Gold Futures (GC)
3. Diversity of Markets
Futures contracts exist for a variety of markets, and often make otherwise inaccessible markets tradeable for retails traders. What about trading markets such as Corn, Cotton, Milk, and Wheat? Those are just a few of the markets accessible through futures. In fact, they are so many that you usually divide them into a couple of categories.
The categories are:
With this many futures markets to choose from, you have many markets to expand to. This in itself is one of the most significant benefits of futures trading. With trading strategies in varying markets, you will be able to produce portfolios with a higher drawdown to profit ratio, and achieve higher returns at a lower risk, since the strategies are mostly uncorrelated.
With a portfolio of strategies that trade only one market such as equities, you will find that it becomes harder and harder to discover strategies that are uncorrelated as you find more strategies. Having many markets to build trading strategies in, makes finding uncorrelated strategies easier.
4. Short Selling
In markets like the S&P 500, or other equity indexes, you will struggle to find strategies that go short. The upward bias of these markets is strong enough to erase most bearish edges in the market. However, finding strategies that go short is possible, and we ourselves have many strategies that go both long and short in the market indexes.
Futures are flexible in that they let traders go short as easily as taking long positions. With stocks, for example, your short order for a long time had to be placed one tick above the last traded price. This rule was called the uptick rule, and was abolished in 2007. However, it is still imposed on some stocks on limited occasions when the stock price has dropped more than 10% from the previous day’s close,
Another aspect to consider is that short selling might become suspended in times of market volatility. There is also the chance that there are no stocks available to lend for short selling, which will leave you with your order unfilled.
With futures, there are no such limitations. Short orders can be placed at the last traded price, you can always go short, and as far as we know, short selling has never been suspended. All these factors combined make futures the perfect choice for traders who want to go short in the markets.
5. Low Costs
Futures are very cheap in relation to the market exposure you get with one contract. The commission can be as low as 0.25$ per side, and together with low slippage, futures emerge as low-cost alternatives to other securities.
6. No Time Decay
Options suffer from time decay, meaning that their value decreases as the expiration date draws closer. Futures do expire, but they do not suffer from time decay.
Futures are great for many types of traders. They offer leverage, low costs, short selling and liquid markets, all in one package. At the Robust Trader, a majority of our trading is carried out on the futures markets, and we recommend other traders to look into futures as well.
On our edge and strategy page, you can find edges for many futures markets!