Over the years, industry surveys of more than 10,000
prospects have determined their specific questions about futures trading. When an account
executive answers each of these questions honestly and completely, he (or she) opens more
accounts than a broker who does not. More importantly, informed clients are better
clients.
Here are answers to the questions that overcome many of
the barriers to gaining new clients.
Is there any truth to
stories I have heard of some investors being wiped out in futures?
Yes, it does happen; however, it is usually because the
investor tries to make a killing, and exposes himself to considerable risk – more
risk than the investor is in a position to handle. For example, speculating in a highly
volatile commodity with little capital, and adding to the position when the market moves
favorably (rather than liquidating some of the original contracts at a profit) could be an
expensive mistake. Like any business transaction, the futures markets can be approached
with reckless abandon, or with common sense and good business judgment.
Is there any truth to
stories I have heard about people becoming millionaires on small amounts of capital in
futures?
Yes, there have been such cases (although not as common as
they might seem). A number of today's most successful money managers reportedly have
launched their careers on such successes. The potential for large profits is inherent in
the futures market; however, when there is an opportunity for large profits, there is also
a corresponding risk potential.
Do most futures traders
lose money?
The U.S. Department of Agriculture conducted a study
several years ago of people who speculated in agricultural commodities. They found that
only 25% of the speculators made money. The study further showed that most of the traders
started with $5,000 or less, and went through their capital in just six months. The
average loss was about $2,000. These statistics reflect two of the major pitfalls a
futures trader should avoid: too much trading, and too little capital. For specific
pitfalls traders and brokers should avoid, see Why Most Futures Traders Lose Money (Center
for Futures Education, Inc., Grove City, PA, 1989).
Is there any chance
someone would try to deliver 5,000 bushels of soybeans to me if I don't sell them in time?
This is a standard joke in the industry. It is totally
false. Accidental delivery to your front yard can not happen. "Delivery" of
grain (and many other commodities) takes place in the form of a warehouse receipt for the
physical commodity. With precious metals, for example gold and silver,
"delivery" occurs in the form of a bank document guaranteeing the quantity and
quality of the metal in the bank's vault. Whatever the commodity, the delivery process
begins with a "notice of intention to deliver," not with the physical commodity.
Also, before delivery of any commodity can occur, payment or financing of the total
contract value must be arranged. Then the brokerage firm must issue delivery instructions,
including method of shipment, place of delivery, and delivery date.
Now can you sell what you
don't own in futures?
You don't need to have the physical commodity or own a
contract for the commodity to go short (sell). You are simply agreeing to sell the
physical commodity at a later date. You also have the opportunity to repurchase the
contract before delivery is required.
Often, it is easier to make money on the "short"
side because prices tend to move more sharply and quickly when declining than when rising.
Also, unlike the stock market, you don't have to wait for an up-tick before going short.
What about all the
shouting and arm waving in the futures pits?
It doesn't look very professional. A futures trade is a
precise financial transaction. There is direct contact between the buyer and seller; every
order is confirmed visually, orally, and in writing. All orders and fills are
"time-stamped." At the end of each trading day, all completed trades must
balance – every filled sell order must have a corresponding buy order, and vice
versa, all with the proper number of contracts and at the agreed prices.
At the end of each trading day, customers' accounts are
settled, listing all open positions; the trading activity for that day (if any); all
pertinent dates, purchase prices, and settlement prices; open equity (the value of open
positions); total equity; and how much each account is worth.
Isn't futures trading just
gambling?
No. The futures markets permit producers or owners of
commodities (e.g., wheat, sugar, gold, stocks, bonds) to transfer the risk of growing or
owning these commodities to futures speculators. Those who use the futures markets to
transfer risk are called hedgers. Speculators assume the risk of price change that hedgers
seek to avoid. Speculators seek the opportunity to profit. When a speculator assumes price
risk, this allows the hedger to concentrate on the more controllable aspects of his
business. Futures speculation is unlike most investments in that price movements are
magnified by the leverage resulting from deposit requirements representing only 5-10
percent of the full contract value. Additional margin deposits may be required, depending
on market fluctuations. Price changes affecting the hedgers' physical position can be
offset by a comparable price change in the futures position.
Isn't futures trading
risky?
I've heard stories of people losing very large
sums of money in futures.
Yes, like any other speculative, highly-leveraged
financial activity, futures trading can be risky if it is not approached as a business.
Here's an example of imprudent trading: Jim Trader has $30,000 to invest, and thinks the
price of gold is going to rise. If he puts the entire $30,000 into gold futures with
$1,500 margin per contract and the price of gold declines $15, he loses the entire
$30,000. If the price rises $15, he makes about $30,000, less commissions. Notice that
leverage can work for you or against you.
The above example is extreme. Traders should not use their
entire investment amount for margin money. A good rule of thumb is to keep at least half
in reserve as protection against normal market fluctuations.
Also, it is unlikely that an investor would stand by and
do nothing while the market moved against him. An order to liquidate might cut his losses,
which is an important money management technique for successful futures trading.
How much time do I have to
spend each day if I trade futures?
From no time to several hours, depending on the depth of
your involvement. Unless you are prepared to make a thorough study of the markets you plan
to trade, you may do better trading with the help of a good brokerage firm and account
executive. Professionally managed accounts require very little time.
To try and predict prices,
should I use news, like a drought, or those complicated looking price charts?
As you may know, fundamental analysis is concerned with
basic supply and demand information, such as the GNP growth rate, disposable income,
unemployment levels, weather patterns, carryover supplies, and agricultural reports. At
different times, such information impacts on the market differently. Technical analysis is
concerned with price action such as trading volume, open interest, and price movement.
Advocates of a strict technical approach argue that market price is the best indicator in
any situation because it includes expectations and fundamentals. Many traders use
fundamental analysis to determine the direction of the market, and technical research to
time their entry and exit. You may want to learn more about the two approaches before
deciding what works best for you.
How safe is my money? Are
the futures markets financially sound?
Absolutely, unequivocally yes! The Clearing Corporations
of the various commodity exchanges guarantee every transaction on their exchange. The
Clearing Corporation is separate and independent from the exchange. No Clearing
Corporation has ever defaulted on any contract. The Clearing Corporation interposes itself
as a guarantor of every contract, acting as a buyer to every seller and seller to every
buyer. This establishes the Clearing Corporation as the payment and collection agency for
its members and, through them, their customers. Each clearing firm must pay the Clearing
Corporation in full for each day's market activity before the market opens for trading the
next day. Based on the previous day's settlement prices, payments are made by wire
transfer. Each clearing firm begins each new day of operation without debt to the Clearing
Corporation. In this way, debt exposure is limited. Clearing firms, in turn, collect from
or pay (credit) their customers daily. This is how the Clearing Corporation effectively
guarantees performance of every cleared contract. Their obligations are backed by
guaranteed funds deposited by the clearing firms, by the Clearing Corporation's own
capital, and by its power to make assessments on its clearing firms. In addition, Federal
Regulations require customers' margin funds to be segregated from the other assets of any
firm licensed as a futures broker. No client of any clearing member has ever lost money
due him.
Are there any trading
rules I should follow?
Several commodity exchanges and others have published
materials that include excellent guidelines. Basic Training for Futures Traders, and
Advanced Training for Futures Traders (Center for Futures Education, Inc., Grove City, PA,
1989) may also be helpful.
How much does it cost to
open an account?
Different brokerage firms have different minimums. Also,
it depends on whether you trade futures or options on futures. You may be able to open a
managed account for as little as $5,000, or invest in a fund for less than a normal
trading account. There are many professionals who suggest that you should not open a
speculative account with less than $25,000, although some reputable firms accept accounts
for less.
What's a good way to
start?
You may want to select a commodity you are comfortable
with, perhaps a product related to your business or where you live, or simply one or two
you find interesting. Then you may want to try "paper trading" (practice
trading). Don't be in a hurry to trade. If you don't have enough risk capital to trade
properly, wait until you do. The markets and opportunities will be here...whenever you're
ready.
How big is the futures
industry?
Compared to the securities industry, it is relatively
small. For instance, estimates indicate their are over 30 million people trading
securities, while less than a half-million trade futures. There are about 3,000 stocks on
the New York and American Stock Exchanges, while there are about 50 actively traded
futures contracts. Futures trading was established when the Chicago Board of Trade
officially opened on April 3, 1848. Since then, particularly in recent years, trading
volume has soared. The industry total in 1970 was about 13 million contracts, in 1980,
almost 100 million contracts, and now, annual volume is over 200 million contracts.
