How risky are futures?

Futures as an investment asset are not inherently riskier than other investment assets, such as equities or currencies. Trading the S&P 500 index futures contract cannot be said to be substantially riskier than investing a mutual fund or exchange-traded fund (ETF) that tracks the same index. The U.S. Treasury bond futures contract is one of the most heavily traded investment assets in the world. As with any similar investment, such as stocks, the price of a futures contract may go up or down. Like equity investments, they do carry more risk than guaranteed, fixed-income investments. However, the actual practice of trading futures is considered by many to be riskier than equity trading because of the leverage involved in futures trading.

Leverage is the ability to margin investments with an investment of only a portion of their total value. The maximum leverage available in purchasing stocks is generally no more than 50%. Futures trading offers leverage up to 90% to 95%. This means that a trader can invest in a futures contract by putting up only 10% of the actual value of the contract. The leverage magnifies the effect of any price changes in such a way that even relatively small changes in price can represent substantial profits or losses.

Because of the leverage used in futures trading, it is possible to sustain losses greater than one's original investment. Conversely, it is also possible to realize very large profits. Again, it is not that the actual asset a trader is investing in carries more inherent risk; the additional risk comes from the nature and process of how futures contracts are traded. To handle the additional leverage wisely, futures traders have to practice superior money management by using prudent stop-loss orders to limit potential losses. Good futures traders are careful not to over-margin themselves, but instead to maintain enough free, uncommitted investment capital to cover drawdowns in their total equity. Trading futures contracts requires more trading skill and hands-on management than traditional equity investing.