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Futures and Equties
For those new to trading, understanding the difference between futures and equities and how they are traded can be somewhat intimidating. There are some key aspects of each that every investor needs to trade successfully:
A futures contract is a legally binding agreement to buy or sell a standardized asset at a specific date or within a designated month. These contracts include detailed specifications, such as:
Examples of commonly traded commodities includes soybeans, crude oil, gold, corn, etc, as well as stock indexes and interest rates such as 10-year Treasuries.
To place a buy or sell order for stocks or futures, investors generally need to open an account with a broker, many of whom are known as futures commission merchants. Investors should also familiarize themselves with the various order types available in both markets.
Futures Contracts Expire; Stocks Do Not
This is a significant distinction. Investors can hold shares of a publicly traded company indefinitely, unless the company is acquired or goes private.
In contrast, futures contracts have a set expiration date. For example, a crude oil futures contract for June 2023 will expire on a specific date. As the expiration date approaches, many traders close or “roll” their positions into later months, since many firms do not allow for physical delivery and will settle before expiration.
When investors buy shares of stock, they gain partial ownership of a company, with the ownership percentage based on the total number of shares issued. For example, if someone buys 1,000 shares of a company with 1 million shares outstanding, they own 0.1% of that company.
Owning stock usually provides voting rights on certain corporate matters and the ability to attend the annual shareholder meeting. Shares signify ownership of the company’s assets and the right to participate in future earnings, which are often reported on a per-share basis. Additionally, some companies offer dividends, distributing a portion of their profits to shareholders on a quarterly or annual basis.
Margin Trading in Futures vs. Stocks
In the stock market, buying on margin involves borrowing money from a broker to purchase shares, effectively leveraging a loan. This allows investors to buy more stock than they could otherwise afford, which can amplify both gains and losses.
According to Regulation T by the Federal Reserve, investors with margin accounts can typically borrow up to 50% of the purchase price of eligible securities (some brokerages may require a higher initial deposit).
In the futures market, margin works differently. Traders must deposit a good-faith amount known as the initial margin requirement, ensuring that both parties can fulfill the contract terms. These requirements vary by product and market volatility, usually ranging from 3% to 12% of the contract’s notional value.
Pros and Cons of Trading Futures vs. Stocks
The futures market offers access to essential commodities and can be used to diversify a portfolio, hedge against risks, or speculate on price changes.
For example, an investor might notice a correlation between stock and oil prices and decide to take a short position in oil futures to hedge against potential losses in oil stocks. However, such hedging does not guarantee profits or limit losses, and there is always the risk of incurring losses.
Both futures and stock positions can quickly move against an investor, and high leverage can worsen losses. Margin trading can lead to losses exceeding the initial investment. If market prices move unfavorably for a futures position, it may trigger a margin call, requiring the trader to quickly add more funds. If the trader fails to provide sufficient funds in time, the position may be liquidated.
Margin calls can also occur in stock trading, making it essential to understand the basics of margin trading.
Risk Disclosure:
Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones’ financial security or life style. Only risk capital should be used for trading and onlythose with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.
Hypothetical Performance Disclosure:
Hypothetical performance results have many inherent limitations, some of which are described below. no representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. for example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.
