Choosing The Right Futures Contracts

ADVANTAGES OF FUTURES CONTRACTS
Leverage: Being able to put down a fraction of what would be necessary to control a normal futures contract allows small moves. Leverage sizes of 10 to 1 are not unheard of. This is the biggest advantage that futures contracts allow the trader.

Margin levels: Futures brokers do not require as much margin as traders who want to trade stocks on margin. There is a minimum margin level but compared to the 25% needed for buying stocks on margin, the levels are in favor of the futures trader. These lower margin levels are what allow the enormous leverage potential.

Smaller number of securities to master: The stock universe is vast. There are so many stocks a trader needs to know that it can become tiresome. In the futures arena, by contrast, there are far fewer choices. Of course, because of their increasing popularity, the futures universe is quickly becoming congested. At this time, there are still far more stocks to trade compared with futures.

No need to diversify your portfolio: Stock traders and self-directed investors never find it wise to have all their money tied up in one security or sector for very long. Instead, you need to diversify your portfolio. Diversification protects you from a total collapse if one sector underperforms. Portfolio diversification is time consuming and can be very difficult in the stock market, but it is not an issue in the futures market; few traders will place all their available capital in one trade. Instead, they always have reserve capital in case a new opportunity presents itself.

Long or short: When a self-directed investor speaks about stocks, they are mostly talking about going long or buying in the hope the stock will increase in value. Shorting stocks is still considered taboo and some even regard it as a terrible thing to do. Regardless, shorting stocks is not easy and the margin levels needed too costly for an average investor. Futures can be bought or sold going long or short with few problems.

Margin requirements: The margin requirements for trading a regular futures contract can still be an expensive proposition for smaller investors and traders. They have become pricey for all but the largest trading firms. The maintenance margin on some futures contracts can be bigger than some investors have of actual capital.

Harder to find information: New investors coming to the world of futures often find it difficult to follow the market. While this has changed in recent years, it can still be difficult for newer investors to follow. It can be time consuming and confusing to understand many markets that are traded. This lack of knowledge often scares investors away from the futures market altogether.

Trading plan: Many new investors frequently enter the futures market with a plan but quickly find it to be incomplete because of how fast profits and losses can be realized. Paper trading will not help solve this issue. Instead, only sound trading strategy and good money management will keep new traders around to trade another day.

Tough training ground: Many experienced futures traders will advise a novice not to jump right in and trade the regular contracts. Trading without sufficient experience can be very costly; often, this is what drives the new trader away. It is not uncommon to hear horror stories about being unable to meet a margin call. Experience could be gained but often at the cost of the new trader’s capital.

ADVANTAGES OF MINI CONTRACTS
Leverage: While the leverage is not the same as those on the regular contracts, a trader can still profit with the leverage on the mini contracts.

Margin rates: Margin levels are even smaller with mini contracts when compared to their regular-sized cousins. This allows a trader with less capital to enter the market. Mini contract margin levels are tiny compared with the required margin to trade stocks. These smaller margin levels mean less capital is needed to trade a mini futures contract.

Small number of securities to learn: Just like the regular contract, a futures trader has fewer securities to follow.

Long or short: Quickly going long or short makes little difference. There is no difficulty following a downward trend and profiting from it. The “buy long” thinking prevalent among most stock traders is not necessary.

Training ground: Mini contracts are ideal for new futures traders to learn to develop or refine their trading strategy. The risk associated with trading minis is not as great as the risk that comes with trading regular contracts. In addition, many successful futures traders get their start by trading mini contracts. Indeed, we can view the mini contracts as the minor leagues. It’s a great place to learn and refine your strategy as well as grow your capital.

There is a misguided idea that only those with limited capital and little experience trade the mini contracts. This is not the case. That said, they do have disadvantages a trader needs to be aware of.

Liquidity: This is a problem with any tradable security. You must make sure there is enough buying and selling in the mini contract you are interested in before you decide to open a position. It is also important to note that just because the regular contract is trading with a lot of liquidity does not mean the mini contract will be as well. There can be a big difference between the liquidity found in the regular contract and a mini contract for the same commodity or futures.

Commissions: Brokerage firms will not charge you less to trade the mini contract, so a smaller contract size does not mean fewer commissions. You will be charged the same rates as you would if you traded regular contracts. This is important when factoring winning and losing trades.

WHICH ONE SHOULD I TRADE?
Beginner: If you have limited trading experience in stocks but no experience in trading futures, then mini contracts are right up your alley. Trading mini futures will allow you to gain experience in trading futures without the massive risk and hefty margin levels associated with the regular contracts. Consider paper trading mini contracts before trading with real money to get an idea of what it will be like to make trades. At this level you want to protect your capital, so you can be around for future trading opportunities. Money management lessons are well learned for beginners trading mini contracts.

Mini contracts and regular contracts have their needs. Mini contracts are opening the world of futures trading to individual investors. This means more liquidity will come as more money is poured into these mini contracts. Deciding on which contract is right will depend largely on two points: Your level of experience and your level of capital.

Clear winners can only be decided by the trader. For some, a regular contract is the only way to trade futures, while for others, the mini contracts are the best fit. It’s up to you.

SUGGESTED READING
Devcic, John [2010]. “The Ever So Fashionable Mini Contracts,” April, Working-Money.com.
_____ [2010]. “Choosing The Right Hardware,” Technical Analysis of STOCKS & COMMODITIES, Volume 28: March.
_____ [2009]. “Leveraged ETFs,” Technical Analysis of STOCKS & COMMODITIES, Volume 27: December.
_____ [2009]. “Get Shorty,” Technical Analysis of STOCKS & COMMODITIES, Volume 27: November.