Futures trading is a high-risk form of investment that can potentially be lucrative, but traders should consider this form of trading carefully before diving in. This includes understanding how futures trading works and the risks that come with it. This article will discuss some common concerns when it comes to trading futures, and how you as a trader can stay informed and make the most of your trades.
If you are looking to trade futures, you can check out Saxo.
Without further ado, let’s get started.
Leverage
One of the significant risks associated with futures trading is leverage. When using leverage, traders can gain exposure to more prominent positions than they would not otherwise be able to access through cash alone. However, while traders can increase the overall profit a trader makes, it can also dramatically increase the losses a trader may suffer if their position goes against them.
The wise thing to do is not to over-leverage your trades. Even if a position is attractive, you should ensure you have enough funds in your account to cover any losses. If you are new to futures trading, it may also be a good idea to utilise only very low leverage. You can always increase your position size when you have more experience, but you may never recuperate substantial losses.
Volatility
Certain markets may be more volatile than others, meaning prices can move in opposite directions unpredictably and/or fluctuate hugely. This can lead to sudden and unexpected losses.
The best way to manage volatility is to set up risk management strategies, from not over-trading to learning about hedging. As futures contracts are legally binding, it is important to figure out how you can minimise your risk when trading in these other ways.
Margin calls
Margin calls are a common risk associated with trading futures; when an account’s equity falls below a certain level, the broker will call a margin closeout and liquidate positions. It can lead to significant losses if the market moves against a trader’s position before they can respond. One good way to prevent margin calls is to always have sufficient funds in your trading account, taking fewer risks, and taking on smaller positions (with lower leverage).
Lack of liquidity
Futures contracts are traded on futures exchanges. Depending on the underlying commodity that is traded, they may not be as liquid as other instruments. If you have an eye on a certain instrument, such as soybeans, metals, or corn, it may be worth checking what the state of the futures market is and how liquid it is. You may also consider using other types of financial derivatives to trade these commodities.
Regulatory risk
The UK has strict regulatory requirements for trading futures. These rules are designed to protect investors from fraud and manipulation, but it can also mean that traders face additional restrictions when entering or exiting trades compared with other markets. A consideration traders must make therefore relates to the brokers they want to work with. Ensure they have all the licenses required to operate in the UK and they follow laws and regulations closely.
Counterparty risk
When trading futures, there is always the risk that the counterparty (the other party in the transaction) may default on their obligations. It can lead to losses if a trader has positions open when this happens, as they will only be able to exit them if another trader takes up the other side of the contract. Generally, this risk is not too high in futures trading, as futures exchanges follow strict regulations and vet their participants. However, one way to lower counterparty risk is to work with reputable and reliable brokers.
Exchange fees and commissions
Exchange fees and commissions are often charged when trading futures, which can reduce profits significantly. There may also be different commissions and fees required, depending on the instrument you trade and the size of your contract.
It is essential to factor any additional costs into your trading strategy to ensure you can stay within expected returns. It is also vital that the brokers and futures exchanges you work with and participate in do not have hidden charges that could eat into your potential profits.
Overconfidence
Finally, one consideration that traders should take into account when trading is their psychology and attitude. Overconfidence can be a significant risk when trading futures. Traders may become complacent after making several successful trades, resulting in misplaced optimism and losses due to poor decision-making.
To avoid this, they should make sure they evaluate markets carefully and not rely heavily on past price patterns. By treating every trade as an individual one and monitoring markets carefully, you can make better trading decisions overall.
Additional points to note when trading futures
On top of the considerations above, there are also additional points to follow to ensure you make the most of your trades.
Research and understand the market
Understanding how futures contracts are priced, traded, and settled before entering a position is essential.
Have an exit strategy
It is vital to have an exit strategy when you place a trade, and not just when things go wrong.
Utilise available tools and resources
Many tools and resources are available to traders, such as charting platforms and market analysis software; utilising these can help analyse the markets more accurately.
