Trading in futures is, as we all know, quite similar to trading in the cash market. Futures, on the other hand, are leveraged because they merely require a margin payment. If the price change goes against you, however, you will have to pay mark to market (MTM) margins. Trading futures presents a significant difficulty in terms of minimizing leverage risk. What are the dangers of investing in futures rather than cash? What’s more, what are the risks of trading in the futures market? Is it possible to utilize efficient day trading futures strategies? Here are six key techniques to limit the danger of using leverage in futures trading.
Avoid using leverage just for the sake of using it. What exactly do we mean when we say this? Assume you have a savings account with a balance of Rs.2.50 lakhs. You want to invest the funds in SBI stocks. In the cash market, you can buy roughly 1000 shares at the current market price of Rs.250. Your broker, on the other hand, claims that you can purchase more SBI if you buy futures and pay a margin. Should you invest in futures with a notional value of Rs.2.50 lakh or futures with a margin of Rs.2.50 lakh? You can acquire the equivalent of 5000 shares of SBI if you buy it with a margin of Rs.2.5 lakh. That implies your profits could rise fivefold, but your losses could also rise fivefold. What is a middle-of-the-road strategy?
That brings us to the second phase, which is deciding how many SBI futures to buy. Because your available capital is Rs.2.50 lakh, you’ll need to account for mark-to-market margins as well. Let’s say you predict the shares of SBI to have a 30% corpus risk in the worst-case scenario. That means you’ll need Rs.75,000 set aside solely for MTM margins. If you want to roll over the futures for a longer length of time, you must throw in a monthly rollover cost of approximately 1%. So, if you wish to extend your loan for another six months, you’ll have to pay an additional Rs.15,000 to do so. Additional Rs.10,000 can be provided for exceptional volatility margins. Effectively, you should set aside Rs.1 lakh and spend only Rs.1.50 lakhs as an initial margin allowance. That would be a better way to go about calculating your initial margins.
You can hedge your futures position by adding a put or call option, depending on whether you’re holding futures of volatile equities or expecting market volatility to rise dramatically. You may ensure that your MTM risk on futures is largely offset by earnings on the options hedge this manner. Remember that buying options has a sunk cost, which you should consider carefully after considering the strategy’s risks and rewards.
Use rigorous stop losses while trading futures. This is a fundamental rule in any trading activity, but it will ensure that you exit losing positions quickly. Is it feasible that the stock will finally meet my target after I set the stop loss? That is entirely feasible. However, as a futures trader, your primary goal is to keep your money safe. Simply exit your position when the stop loss is triggered. That’s because if you don’t employ a stop loss, you’ll end up losing money.
At regular intervals, book profits on your futures position. Why are we doing this? It ensures that your liquidity is preserved, and it adds to your corpus each time you book gains. This means you’ll be able to get more leverage out of the market. Because you’re in a leveraged position, it’s just as crucial to keep your trading losses to a minimum as it is to maintain your trading winnings to a minimum.
Last but not least, keep your exposure from becoming too concentrated. If all of your futures positions are in rate-sensitive industries, a rate hike by the RBI could have a boomerang impact on your trading positions. To ensure that the impact of unfavorable news flows does not become too prohibitive, it is always advisable to spread out your leveraged positions. It has an average angle as well. When we buy futures and the price of the futures drops, we usually average our positions. Again, this is risky since you risk overexposure to a certain business or theme.
Leverage is an integral aspect of futures trading. How you manage the risk of leverage in futures is entirely up to you.
Is margin required to trade futures?
Although you must have enough in your account to cover all day trading margins and variations that come from your positions, there is no legal minimum balance you must maintain to day trade futures. The day trading margins differ from broker to broker.
Is it possible to trade without margin?
For those unfamiliar with prop companies, you fund an account with a firm and then begin trading with the firm’s money after finishing a training course. Because you are covered by the prop firms account, you can use a smaller percentage of the funds for day trading (i.e. $5,000) instead of the entire $25,000 upfront.
While this is theoretically conceivable, you have no business trading in a prop firm if you have less than $25,000 in your account.
I get that you can utilize the prop firm to learn, but I’ve yet to encounter a trader who can live off earnings from a $25,000 account balance, especially when those profits must be split with the firm.
As a result, while it is technically possible to day trade without a margin account, the options available are limited.
Is it possible to trade futures on Robinhood?
In its early days, Robinhood distinguished out as a brokerage sector disruptor. The fact that it didn’t charge commissions on stocks, options, and cryptocurrency trading was its main competitive edge. The brokerage industry as a whole has joined in eliminating commissions, so that advantage has been neutralized. Despite growing cost competition, Robinhood has built a strong brand and niche market among young, tech-savvy investors, thanks to a simple design and user experience that concentrates on the fundamentals. In an effort to attract new customers and deepen the financial relationship with existing ones, the broker recently offered cash management services and a recurring investment function.
Is it possible to trade futures on Webull?
On Webull, what types of securities can I trade? We allow you to trade stocks, options, cryptos, and exchange-traded funds (ETFs) that are listed in the United States. There are also initial public offerings (IPOs) available. At this moment, we do not support over-the-counter (OTC) stocks, warrants, or futures/forex.
How do you stay away from margin?
Margin calls can be a stressful situation with significant financial consequences. To raise the equity in your account, your brokerage business may sell stocks you own without alerting you and without consideration to tax ramifications. As a result, consider the following tips to reduce your chances of receiving a margin call:
- Prepare for volatility by keeping a large cash reserve in your account to protect you if the value of your loan collateral drops unexpectedly.
- Set a personal trigger point: Have extra liquid resources on hand in case you need to fund your margin account with cash or securities.
- Keep an eye on your account on a daily basis and consider setting up notifications to tell you if the value of your stock drops considerably.
- Make use of your broker’s internet resources: Use these tools to help you calculate the impact of margin requirements due to trading activity and/or price variations in your account’s securities. Fidelity users, for example, have access to a Margin Calculator that calculates the impact of hypothetical equity trades on margin balances and buying power while also taking into consideration the account’s individual margin requirements. Here’s a look at the Margin Calculator in action.
What if you don’t want to utilise margin at all?
While margin is always available in your C2 Model Account, you have the option of not using it. This implies that you should purchase half of what you are permitted to purchase.
Is it possible to have a margin account without using margin?
Margin gives you more buying power, but it also puts you at risk of bigger losses. Here’s everything you should know about margin.
Understand How Margin Works
Let’s imagine you buy a stock for $50 and it rises to $75 in value. If you acquired the stock in cash and paid for it in full, you’ll get a 50% return on your investment (i.e., your $25 gain is equal to 50% of your $50 initial investment). However, if you bought the stock on margin paying $25 in cash and borrowing $25 from your broker you’ll get a 100% return on your investment (i.e., your $25 gain is equal to your initial $25 investment).
*For the sake of simplicity, the interest you’d owe your broker on the $25 margin loan you used to buy this stock is not included in this example. Your actual return would be significantly less than 100 percent after paying this interest to your broker.
The disadvantage of employing margin is that if the stock price falls, big losses can quickly accumulate. Let’s imagine you bought a stock for $50 and it drops to $15. You would lose 70% of your money if you bought full price for the stock. If you bought on margin, though, you would lose more than 100% of your money. You would owe your broker an additional $10 plus the interest on the margin loan, in addition to the total loss of your $25 initial investment.
Investors who put up an initial margin payment for a stock may be asked to submit further cash or securities to the broker from time to time if the stock’s price declines (a “margin call”).
Some investors have been surprised to learn that their brokerage business has the power to sell securities purchased on margin without prior notice and at a large loss to the investor.
If your broker sells your stock after it has dropped in value, you will miss out on the opportunity to recuperate your losses if the market recovers.
Recognize the Risks
Margin accounts can be quite dangerous, and they are not suitable for everyone. Before you open a margin account, you should be aware of the following:
- To cover market losses, you may need to put additional cash or securities into your account on short notice.
- When the value of your securities is reduced by declining stock prices, you may be forced to sell some or all of them.
- To repay your margin loan, your brokerage firm may sell part or all of your stocks without informing you.
- You have no say in whatever stocks your brokerage business sells in your account to pay off your margin loan.
- Your brokerage business is not compelled to provide you early notice if it decides to increase its margin requirements at any time.
- Understanding how a margin account works and what happens if the price of the securities bought on margin falls in value.
- Understanding how interest charged by your broker for borrowing money affects the total return on your investments.
- Inquire with your broker about whether trading on margin is right for you based on your financial resources, investment goals, and risk tolerance.
Read Your Margin Agreement
Your broker will require you to sign a margin agreement in order to open a margin account. The margin agreement may be included in or distinct from your general brokerage account opening agreement.
The margin agreement specifies that you must follow the margin rules set forth by the Federal Reserve Board, self-regulatory organizations (SROs) like FINRA, any applicable securities exchange, and the firm where you opened your margin account. Before you sign the contract, make sure you read it well.
The margin agreement, like other loans, defines the terms and conditions of the margin account.
The agreement, for example, explains how the loan’s interest is calculated, how you are accountable for repayment, and how the assets you buy act as collateral for the loan.
Examine the contract carefully to see what notice, if any, your firm is required to give you before selling your stocks to repay the money you borrowed or changing the terms and conditions under which interest is computed.
Changes in the method of computing interest must be communicated to customers at least 30 days in advance.
Know the Margin Rules
Margin trading is governed by rules established by the Federal Reserve Board, SROs such as FINRA, and stock exchanges. Brokerage firms can form its own organizations “house” criteria that are more stringent than those set forth in the guidelines. Here are some of the most important rules to remember:
Before trading on margin, FINRA, for example, requires you to deposit a minimum of $2,000 or 100% of the purchase price of the margin securities, whichever is less, with your brokerage firm.
This is referred to as the “The bare minimum.”
Some companies may demand a deposit of more than $2,000.
You can borrow up to 50% of the purchase price of margin securities, according to Federal Reserve Board Regulation T.
This is referred to as the “The first margin.”
Some companies demand a deposit of more than 50% of the buying price.
FINRA rules oblige your brokerage firm to enforce a margin call once you purchase margin securities “On your margin account, there is a “maintenance need.”
This is a good example “The “maintenance requirement” establishes the minimum amount of equity in your margin account that you must maintain at all times.
The value of your shares less the amount you owe to your brokerage business is the equity in your margin account.
This is required by FINRA rules “At least 25% of the total market value of the margin securities is required as a “maintenance requirement.”
Many brokerage houses, on the other hand, have higher maintenance needs, ranging from 30 to 40%, and sometimes even more, depending on the type of assets purchased.
Here’s how maintenance needs operate in practice.
Let’s say you borrow $8,000 from your firm and spend $8,000 in cash or securities to buy $16,000 worth of securities.
If the market value of the shares you bought falls to $12,000, your account equity will decline to $4,000 ($12,000 – $8,000 = $4,000).
If your company requires a 25% maintenance fee, you’ll need $3,000 in your account (25 percent of $12,000 = $3,000).
In this situation, you have enough equity because the $4,000 in your account exceeds the $3,000 required for upkeep.
However, if your company requires 40% maintenance, you will not have enough equity.
You’d need $4,800 in equity (40 percent of $12,000 = $4,800) to work at the firm.
The firm’s $4,800 maintenance cost is less than your $4,000 in equity.
As a result, since your account’s equity has fallen $800 below the firm’s maintenance minimum, the firm may issue you a “margin call” to deposit extra equity into your account.
Understand Margin Calls You Can Lose Your Money Fast and With No Notice
If your account falls below the business’s minimum maintenance requirement, your firm will usually make a margin call and ask you to deposit more cash or securities. When a margin call occurs, you won’t be able to buy any more securities in your account until the margin call requirements are met. If you fail to meet the margin call, your firm will sell your securities to bring your account’s equity up to or over the firm’s minimum maintenance requirement.
Your broker, on the other hand, may not be compelled to initiate a margin call or otherwise notify you if your account falls below the firm’s minimum maintenance requirement.
Your broker may be able to sell your securities without your permission at any time.
Even if your firm offers to give you time to boost your account’s equity, most margin agreements allow it to sell your securities without waiting for you to meet the margin call.
Options Trading Using Margin
Using margin to trade options can put you at danger of losing a lot of money. To trade options, most brokerage firms need you to have a margin account, but you cannot use margin to purchase options contracts. However, certain brokerage houses may allow you to sell (or write) options contracts on margin. Selling options contracts as part of an options strategy can result in big losses, and using margin can amplify those losses. Some of these tactics may put you at risk of losing more than your initial investment (i.e., you will owe money to your broker in addition to the investment loss). Read our Investor Bulletin “Leveraged Investing Strategies – Know the Risks Before Using These Advanced Investment Tools” for more information on options trading on margin.
Interest Charges Money is not free
Margin loans, like other loans, have an interest component. This interest affects your investment return directly, raising the amount your investment must earn to break even. Interest rates at brokerage firms might differ significantly. Remember to think about this cost before you open a margin account.
Account Transfers
If you intend to move securities from a margin account to another brokerage firm, be sure you are familiar with the procedures for transferring securities out of these accounts at your current brokerage firm. When a margin account has an outstanding margin loan, many firms will not enable you to move any securities out of the account. These rules are usually spelled out in your account agreement or in a separate margin agreement that you signed when you first opened the margin account. Before transferring securities from a margin account, ask your present firm to provide and explain these rules to you. Please read our Investor Bulletin: Transferring Your Investment Account for more information on account transfers.
Margin in Fee-Based Accounts
Some investment accounts charge an asset-based fee (annually, quarterly, or monthly) equivalent to a percentage of the market value of the securities in the account, rather than charging for individual transactions. Remember that the asset-based charge is normally based on the value of all assets in the account and does not account for the debt used to purchase margin securities if you utilize margin in these accounts.
Margin Loans Carefully Consider the Risks of Using Margin Loans for Non-Securities Purposes.
Some brokers may allow you to use margin loans for a range of personal or company financial goals, including as purchasing real estate, paying off personal debt, or supplying capital, in addition to purchasing stocks. The use of margin loans for non-securities purposes has no effect on how they work. These loans are still backed by the securities in your margin account, and as a result, they are subject to the same risks as buying securities on margin. These loans have different terms and conditions depending on the broker, but they are usually listed in the margin agreement. Before using these loans for any non-securities purpose, you should carefully examine the margin risks stated above, as well as any fees that may be connected with them.
Securities Lending
If the investor has any outstanding margin loans in the account, some margin accounts allow the brokerage company to lend out securities in the account to a third-party at any time without warning or reimbursement to the account holder. While your shares are being lent out, you may lose the voting rights that come with them. Any dividends associated to leased out shares will still be paid to you. The payment you get, however, may be taxed differently because you are not the actual holder of the shares. Inquire if your brokerage firm’s margin accounts allow for securities lending, and if so, how it works and how it can affect the securities in the account.
Pattern Day Trader Margin Requirements
For a consumer, this is a big deal “FINRA mandates the broker to impose extra margin restrictions on the customer’s margin account if the customer is a “pattern day trader.” In general, these include a $25,000 minimum equity requirement and a restriction that limits the purchase power of equity securities in the margin account to four times the maintenance margin excess as of the preceding day’s close of business. For more information on these, go here “Please see our Investor Bulletin: Day Trading Margin Rules for pattern day traders’ margin requirements.
Additional Resources
Investor Information Bulletin “Know the Risks of Leveraged Investing Strategies Before Using These Advanced Investment Tools.”
Please read our Investor Bulletin: Margin Rules for Day Traders for more information on margin rules for day traders.
“Purchasing on Margin, Risks Involved with Trading in a Margin Account” and “Understanding Margin Accounts, Why Brokers Do What They Do” are FINRA investor bulletins.
White Paper from the SEC’s Division of Economic and Risk Analysis “Margin Traders’ Financial Ignorance and Overconfidence.”
Visit Investor.gov, the SEC’s website for individual investors, for more information on investor education.
Investor Alerts and Bulletins are sent to you through email or RSS feed from the OIEA.
OIEA can be followed on Twitter.
On Facebook, follow OIEA.
Key Questions You Should Consider Before Buying Securities in a Margin Account
- Do you realize that margin accounts carry a lot greater risk than cash accounts, where you pay in full for the securities you buy?
- Are you aware that when you buy on margin, you risk losing more than the amount you initially invested?
- Have you asked your broker about how a margin account works and whether trading on leverage is right for you?
- Are you aware of the charges associated with borrowing money from your company and how these costs effect your overall return?
- Are you aware that if you don’t have enough equity in your margin account, your brokerage business can sell your shares without notifying you?
Is it possible to lose money when trading futures?
It is possible to lose more than one’s original investment when trading futures because of the leverage applied. On the other hand, it is also feasible to make extremely big earnings.
How much does trading futures cost?
How much does trading futures cost? Futures and options on futures contracts have a cost of $2.25 per contract, plus exchange and regulatory fees. Exchange fees may vary depending on the exchange and the goods. The National Futures Association (NFA) charges regulatory fees, which are presently $0.02 per contract.