The Disadvantages of Futures Trading
Futures trading can appear to be a quite attractive investment option. Many investors have made a fortune with futures trading, including John Henry, the principal owner of the Boston Red Sox baseball team. However, others have lost large sums of money, enduring the disadvantages of futures trading. The primary disadvantage is quite evident: The word "futures" says it all. You have limited or no control over many factors involved in futures investment contracts.
Popular Futures Choices
Crops are popular choices. Corn, wheat and soybeans are common options for futures contracts. Oranges and orange juice are equally popular options. Natural resource futures, such as natural gas, oil, gasoline and coal, are also popular trading choices. Foreign currency trading, often shortened to Forex, has significantly grown in popularity during the new millennium. You could even invest in various interest rates, hoping that these rates will rise in the future.
Controlling Future Events
The overriding disadvantage of futures trading is the lack of control over future events. For example, you've invested in orange juice futures. But Florida suffers a devastating freeze, killing off one-half of the orange crop. While supply and demand theory suggests the price will increase, the lack of supply can also result in massive losses. Weather disasters, over which you have no control, can wipe out all types of crops. You face similar risks with foreign currency futures, as various factors, all beyond your control, such as political issues or country borrowing defaults, could devalue a country's currency.
Complex Issues for Newer Investors
Along with the obvious risks, such as weather disasters, added risk comes with the complexity of futures contracts. Investors who do not fully understand these complexities can lose substantial money. You must decide if you have the time and inclination to follow national and international weather, political and financial conditions on a regular schedule. New investors must also find experienced professionals registered with the Commodity Futures Trading Commission, as typically licensed stock brokers cannot trade futures contracts.
The leverage offered by futures contracts is both an advantage and a disadvantage. The advantage: You can buy futures contracts for only 5 percent or 10 percent of a contract's value. The disadvantage involves the sometimes fast movement of futures prices. Contract prices can tick up or down daily, sometimes within minutes. If lady luck is not smiling on you on a given day, you'll receive a margin call from your broker advising you that your margin account has dropped below minimum levels, meaning you must transfer more cash to your account immediately.
Futures contracts come with definite expiration dates. Even if you have established fixed prices for the assets in the contract, as the expiration date approaches those prices can become much less attractive to others. At times, this condition can cause futures contracts to expire as worthless investments. Similar to banks that offer too many loans at fixed rates, changes in the market increase the risk that some of their loans will come with well-below market rates. Futures contract expiration dates, as they get closer, come with similar risks.