Investing in stock market futures for tomorrow can turn a modest stake into a fortune, but the odds favour the professionals and in reality you are likely to suffer big losses
When you buy or sell a futures contract, you commit yourself to buy or sell a quantity of a commodity (or currency or financial instrument) in the future. The date and quantity are standard; you fix the price when you buy or sell the contract.
In theory, high leverage makes it possible to turn a modest stake into a fortune in futures. In practice, however, most stock market futures for tomorrow (meaning at some point in the future) wind up losing money.
Successful investors recognize that investing in futures is a form of recreation. You may do it for fun, but don’t count on it for profit.
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Here’s how futures work:
Trading in futures is a long-established and perfectly legal way to bet on price changes in commodity, currency and financial markets. This attracts futures traders.
Here’s an example: The first futures were in commodities, which offer a clear example of the way futures trading works. Say you purchase a March wheat contract at $6.60. That means you’ve agreed to a contract for 5,000 bushels of wheat in March, paying $6.60 each, for a total of $33,000. The seller has agreed to sell that much wheat at that price on that date.
Since the transaction takes place in the future, the buyer and seller only put up a deposit of perhaps 5% of the $33,000. This provides enormous leverage. A 5% price rise represents a 100% gain for the buyer and a 100% loss for the seller.
Futures started out as a convenience for commercial interests. Farmers sell wheat futures to fix their income from this year’s harvest. Bakers buy wheat futures to fix their flour costs. But most futures transactions take place between speculators who are simply betting that prices will rise or fall. Most contracts get closed out prior to delivery.
When you trade stock market futures for tomorrow, you are betting on the direction and speed of coming price changes. Nobody consistently wins these bets. Sometimes you guess right and sometimes you guess wrong, but you pay commissions and fees with every trade. You may feel you have a knack for predicting changes in prices of stock market futures. Many futures traders start out burdened with this belief. Most come to see they were wrong. The reason is simple. The markets determine price changes, and there are extremely intelligent and hard-working people on both the buying and selling sides of every futures market. As a result, most of the time, prices are about where they should be, based on existing information.
Of course, new information comes along every second of every day. No one can consistently predict if the next tidbit of info will push prices up or down, or how much of a push it will deliver. However, professional futures traders have a big advantage over amateurs and hobbyists, just as in every other field.
Here are three reasons to stay away from futures:
Trading in futures is not the same as investing in stocks or funds. There are three fundamental differences investors must be aware of to understand the nature of futures trading:
- Futures contracts have a fixed life, usually under one year. You can hold stocks or mutual or exchange-traded funds indefinitely.
- Futures contracts do not give you any income. Some stocks, and some funds, do provide dividend payments.
- Futures are a speculation—a bet on price movements. To make money, you have to outguess other players by a wide enough margin to pay commissions. Stocks and funds are an investment because they let you profit from economic growth.
Our three-part Successful Investor approach is the best way to make money in the stock market
At TSI Network, we recommend using our three-part Successful Investor philosophy to make money no matter what happens in the market:
- Invest mainly in well-established, mostly dividend-paying companies;
- Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
- Downplay or avoid stocks in the broker/media limelight.
Bonus tip: Avoid gold stock market futures for tomorrow as well as structured products
You have to learn a lot of things to become a successful investor, and few people learn them all in any logical progression. Instead, most of us move from one subject of interest to another, with a lot of zigs and zags in between.
That’s why some investors go through a phase when they know just enough about a particular investment to be a danger to themselves and others.
A gold investing mistake to avoid is structured investments. Brokers sell various structured products for investing in gold and other commodities, while supposedly limiting risk. Most participants will ultimately lose money in these investments. Or they will make a poor return in relation to their risk.
The difference between structured products and gold futures trades is that the losses won’t happen so quickly. However, more of the money you lose will flow into brokers’ fees and commissions, while you’ll typically lose less on the commodity investments themselves.
Futures have many controversies surrounding them. What would convince you to invest in futures regardless of these controversies?
Have you dabbled in the futures market? What was your experience?