Leveraged Futures Trading: An Overview
Increased liquidity and convenience are the two major benefits of trading in futures markets, particularly when compared to going direct in certain commodity markets. Because of this, most full-time traders like trading futures contracts over other underlying assets.
What is Leverage Trading?
Leverage trading involves paying a small financial amount in order to gain significant exposure to grander trading opportunities. This strategy is commonly applied to financial instruments such as commodities, indices, and futures which are available through various brokers. As a trader, your objective is to profit from the price difference between the opening and closing of a trade.
The easy access to leverage trading is another factor that makes futures trading appealing and profitable for individuals who have a solid trading strategy. With this tool, you can create and manage a leveraged trading position by depositing only a small portion of the future contract’s value as margin.
Margin Types in Leveraged Futures Trading
With a fractional cash deposit known as a margin, traders can control much greater holdings when using leverage futures trading. Whereas margin is typically reported as a percentage, leverage is typically expressed as a ratio.
To participate in the futures market, traders often need to deposit up to three different kinds of margin, according to futures brokers. They are as follows:
Initial Margin
All traders must deposit an initial margin amount, which varies from 5% to 10% of the value of a futures contract. This initial margin deposit is a good faith deposit made to the futures clearinghouse through your broker to protect those parties against any trading losses you may have, not a partial payment for the futures contract. In contrast to margin trading in the stock market, where a stockbroker lends money to traders to cover their margin needs, operating on a margin basis in the futures market entails neither making loans nor paying interest.
Maintenance Margin
Your broker will ask you to deposit extra capital known as maintenance margin if you continue to hold a futures position after the market closes. In the futures market, you have to deposit a maintenance margin amount, which is usually between 80% and 90% of the initial margin requirement, in order to keep a position overnight.
Day Trade Margin
Only futures positions opened and closed during the trading day are subject to this form of margin, which is determined by the futures broker. A position is usually marked to market and maintenance margin restrictions are applied if it is not closed before the end of the trading day.
When to Trade Futures Using Leverage
Skilled futures traders optimize their profits by utilizing leverage. Having said that, there are situations in which using leverage might be advantageous:
Significant market top or bottom: If you are reasonably positive that you have located a significant market top or bottom, you might wish to employ leverage to boost the profitability of your trade if your prediction comes true. Trading futures with a trailing stop typically makes sense in this scenario.
A market that is trending consistently: If the futures market looks to be trending in a clear general direction and in a reasonably stable way, you may be able to take advantage of this ongoing directional movement by using futures positions that you have taken in the trend’s direction to increase your profits even more.
When to Avoid Trading Futures Using Leverage
Utilizing leverage can be harmful in some market conditions, here is to watch out for before using leverage in futures trading:
Uncertainty in the market: You might want to stay away from leveraged futures contracts that require you to take on additional risk when the market is particularly turbulent. By increasing their margin requirements, several futures brokers will even actively discourage futures trading under extremely erratic market situations.
When hedging an underlying asset: You are typically better off selling futures contracts in a cash account rather than a margin account if you are using the futures market to hedge physical assets you possess. You can then choose to cash out your futures contracts by buying the physical assets back before the last trading date expires, or you can deliver the physical assets into the futures contract as the delivery date approaches.
Key Tactics for Successful Futures Trading
- Trading leveraged futures contracts can be risky and can lead to significant losses. It is essential to avoid trading with money that you can’t afford to lose, as many new traders lack an understanding of leverage and the financial risk involved.
- Trade with a plan, which includes a tested futures trading strategy, before risking your hard-earned money. Test your plan through demo or practice accounts provided by futures prop firms, or social trading if you are a novice trader.
- Utilize prudent money management techniques to keep your account in business and cut losses, especially when leveraging futures positions. Use only a small percentage of your account’s funds for any given position relative to the balance in your account to help your account withstand a string of losses.
- Don’t overtrade, as it can risk the profits already made by establishing more positions in the market. Specify rules in your trading plan to prevent overtrading and avoid increased futures commission costs.
- Cut your losses promptly in a losing position to avoid worse losses down the road. Keep a stop level in mind while watching the position closely and place protective stop-loss orders with your broker or firm. Be aware of certain levels on the futures stock index charts where other stops may be strategically placed to avoid being targeted by large traders.
