Futures, as financial derivatives, have more pronounced advantages and risks compared to stocks. Let's take a look at both.
Advantages
Advantages
High Liquidity
The standardization and efficiency of futures contracts make the futures market highly liquid. Generally, the liquidity of the futures market is much higher than that of the spot market.
Leverage and Low Transaction Costs
Futures trading adopts a margin system, allowing contract holders to control larger positions with smaller capital. The cost of fulfilling a futures contract is usually a small fraction of the equivalent transaction value in the over-the-counter market.
Low-Risk Settlement
The unique daily settlement system in the futures market effectively avoids counterparty default risk and allows transactions opposite to existing futures positions.
Comparison with Stocks: The advantages of futures compared to stocks are as follows:
Futures Trading | Stock Trading |
---|---|
Lower transaction fees | Higher transaction fees |
Expiration date (monthly/quarterly) | Usually no expiration date |
Futures exchange | Stock Exchange |
No physical ownership | Has ownership |
Usually offers higher leverage, eg. 30 times | Lower leverage, usually up to 4 times |
Risk
Risk
Leverage Risk
The primary risk in futures trading derives from utilizing its high leverage. While it can amplify profits when gains are made, it can also magnify losses in downturns.
In futures trading, traders can open a position with a margin that is significantly lower than the total value of the commodity or asset they are trading. In highly volatile markets, a trader's losses may exceed the initial margin deposit. This can result in an overloss situation where the trader owes more money to the broker than what was initially deposited.
To avoid the occurrence of excessive losses, brokers will set a minimum amount for the margin. If an account's funds fall below this minimum, or "maintenance margin," the broker will issue a margin call.
If the trader does not deposit the required margin within the specified time, allowing the account balance to rise above the required ratio, the broker has both the "right" and "obligation" to forcefully close the trader's positions. This is known as "forced liquidation."
It's worth noting that the leverage in futures is adjustable. The broker's "initial margin" is only the "minimum" amount that must be deposited. Traders can adjust it based on their financial situation and risk tolerance.
How to Adjust the Leverage in Futures? A quick example:
Suppose a commodity futures contract requires a margin of $50,000, with a total contract value of about $1 million, and leverage of about 20 times. If we deposit $100,000, the leverage ratio will immediately drop to about 10 times; if we deposit $250,000, the leverage will be about 4 times.
By adjusting the leverage, the trader can adjust the risk to a level he/she is comfortable with.
Price Risk
This refers to the potential loss of expected benefits due to price fluctuations. It mainly occurs when price changes are contrary to our judgment and order expectations.
Agency Risk
This is the risk that may arise in the process of choosing a futures company and establishing an agency relationship. Proper screening and contract signing with the futures company can mitigate this risk.
Liquidity Risk
This risk arises from poor market liquidity in certain futures products, leading to difficulties in quick and convenient trading.
Delivery Risk
This risk occurs when preparing or carrying out futures delivery. All open contracts must be settled at expiration. Investors must close positions in time to avoid forced liquidation.
Investor-Specific Risks
These risks are related to the investor's qualifications, knowledge level, trading experience, and operational level. They include:
- Poor price prediction ability.
- Full position operation, bearing excessive risk.
- Lack of experience in handling high-risk investments.
Operational Risks
These include risks due to computer system failures or human errors, such as incorrect buying and selling directions, trading software infected with viruses, etc.