Futures – Advantages and Disadvantages

Before I can tell you the advantages and disadvantages of trading futures, it’s important to understand how it differs from trading stocks.

When you buy a stock, you own part of the company. That is, you share ownership with other investors. That’s why we say you buy shares.

Trading futures, on the other hand, requires a contract to buy or sell the commodity in the future. That’s why they are called futures.

You can buy or sell those futures contracts as easily as trading stocks. For that matter, you don’t even have to lay out the money. However, you do tie up resources in the form of margin.

The problem is that the margin held is nowhere near the actual value of the commodity if you were to purchase it. This is known as the Notional Value. It’s calculated as the market value multiplied by the leverage.

Okay, I just threw you two more terms that need definition:

The market value is the price that traders are willing to pay. In general, this is determined by supply and demand. The leverage is the number of units of the future index.

For example, the E-Mini SP& 500 Futures has a leverage of 50. As of this writing it’s trading near a market value of 2100. Multiply that by the leverage (50) and you get $105,000. That’s the Notional Value of the E-Mini S&P.

As you can see, if you buy one E-Mini S&P contract, you are controlling $105,000 in value. However, unlike stocks, you don’t own it. You just have a contract to buy or sell it, depending if you went long or short.

Low Margin Required

What did you actually pay? That’s known as the margin that the broker requires you to hold while that trade is active. It varies, but it’s around $5,000.

If you bought a stock valued at $105,000 you’d have to pay $105,000. If you used margin, it would still require a payment of half of that. The advantage with futures is that you only tie up a small fraction.

However, the disadvantage is that you need to know what you’re doing. If you let a Futures trade get away from you, you are liable for a huge investment. Remember, it’s a contract.

That’s why traders buy and sell Futures contracts without actually ever buying the commodity.

What’s the disadvantage?

When trading futures you have to apply your due diligence in knowing the notional value of the future contract.

If you don’t pay attention to the Notional Value, and a trade keeps going against you and you don’t close the trade at a small loss, it can get out of hand.

You could end up losing a lot of money in a short time. If you reach the limits of your margin, your broker will close the trade if you don’t. That means you’ve been taken out of the market and you may not have the resources to get back in. Game over!

For this reason, you need to stay small. Don’t add to bad trades hoping to lower your cost bases. Rather, just admit that you were wrong and you’ll be around to play another day when an opportunity arises.

Advantages?

There are many, and these are the reasons why I love futures over stocks. The rest of this article will briefly list the advantages with trading futures.

Trading Long and Short

Going short with Futures is just as easy as going long. It’s just a matter of deciding in which direction you think the market is headed.

No Day Trading Limits

There is no day trading limit with Futures. Stocks can only be traded three times in a day before the IRS considers you a day trader. Futures can be bought and sold any number of times in a day, allowing one to take quick profits and benefit from intraday swings.

No Wash Sales Penalties

The IRS does not penalize you for taking a loss and reentering the same trade within 30 days. When this is done with stocks it is considered a wash sale and you lose the benefit of deducting the loss unless you can carry it forward to a future gain on the same stock.

The reason why it’s not penalized for Futures is because Futures pricing are recorded as Marked to Market. I won’t get into that here. You can always do a Google search for the term if interested.

Trading 24 hours

Futures trade nearly around the clock, except on weekends and short periods in between for exchange record keeping.

European Style Trading

Stock Options follow the American Style that can be exercised anytime. When trading stock options, one needs to be careful to avoid being exercised if the option is in the money.

Most Futures Options trade European Style, which can’t be exercised before expiration. There are some exceptions, especially with weeklies. That’s beyond the scope of this article though.

Tax Advantage

Futures and Options on Futures are treated according to IRS Section 1256. That provides a tax advantage since 60% of all gains are considered Long Term. This is true even if held for just a few seconds.

About the author: Glenn Stok writes about trading strategies that he has perfected from over 35 years of investing and trading stocks and futures, including defining risk, trading without emotion, and trading mechanically.

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The Big Oil Comeback

Every week brings another spate of headlines about the heavy blows soon to rain down on the energy sector…

“The Oil Collapse ‘Death Spiral’” is coming soon…

And… “Oil Prices Might Never Recover.”

Apparently, very soon, we will all ditch our gasoline-fueled cars and trucks for Tesla knockoffs. The slow-growth U.S. economy and the rising number of wind- and solar-energy installations around the world will supposedly finish the job.

Boom! Petroleum is “the new coal.”

Don’t believe it. In fact, we may well be entering a new golden era for oil investing – all because of a certain country in Asia with a five-letter name…

If you want to know which economy will have the single largest impact on the global price of oil – and why we will continue to look at the oil sector as an important part of any investment strategy – all you have to do is look at what’s happening in India.

India – with a population of 1.3 billion and a gross domestic product (GDP) growth trend that’s now rising at a faster pace than China (7.5% versus 6.9% in 2015) – is still in the early stages of a massive love affair with crude. And considering that it needs to import about 80% of what it consumes, it’s a love affair that’s growing literally by the month.

In September, oil imports rose nearly 12% compared to year-ago levels. It was the same in August (a 9% increase) when the country brought in a record of nearly 19 million metric tons of crude – the equivalent of nearly 4.5 million barrels a day. By comparison, China, with a more developed economy and nearly 1.4 billion people, imports around 6 million barrels a day.

As the International Energy Agency (IEA) recently noted: “India is taking over from China as the main growth market for oil.”

At the current pace, the country is on track to raise yearly imports by 7% for the second time in a row, having doubled its crude oil imports in a decade’s time.

What’s driving all the demand?

It’s a familiar story – a small, but rising middle class (which makes up about a fifth of India’s population now, say demographers, but is expected to swell to more than 40% by 2030).

And new cars. Lots and lots of new cars.

In 2015, passenger car sales rose nearly 10% to more than 2 million units, the fastest pace in five years. One of India’s largest carmakers, Maruti Suzuki, recently predicted annual sales would hit 5 million a year by the end of this decade.

Keep in mind, all of this is occurring against a backdrop in which the IEA, in its World Energy Investment 2016 report, said current oil wells around the globe are depleting by an average of about 9% a year. Discoveries of new oil reserves are “dropping to levels not seen in the last 60 years.”

Of course, it’s important to ask whether electric-vehicle sales might become a bigger factor and perhaps drain off India’s surging oil demand.

The answer, I’m sure, is yes. But when is anyone’s guess. As India’s Economic Times noted, the country has 400 million people with no access to reliable electrical power. And even in major cities, outages have been common because of a lack of investment in India’s power grid in prior decades. Without reliable power, even the fastest-charging, longest-range electric car or motorcycle is useless.

The situation is starting to change in India, but it’s going to take decades. In the meantime, oil remains the only practical game in town for investors and as a foundation for India’s rapidly developing economy.

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How to Invest and Why You Need a Plan

What makes rich people rich? Looking at the spending pattern of various income groups in the U.S. makes it clear: Savings. The real difference between the rich and the poor is that the rich spend a larger share of their income on savings (pensions and insurance) and education.

Source: WSJ, Labour Department,

When building wealth, preserving wealth, and passing it to the next generation is the formula for financial success it is surprising that less than 20% of Americans do have a written plan when it comes to investing and even retirement [1].

The paradox in human behavior is that we are perfectly rational and capable of planning for a major event in our lives, but this is usually forgotten when it comes to investing. In fact, you will find that only a third of investors have a written plan guiding their investment strategy and retirement plans.

Why is a plan needed?
The investment world is a harsh jungle, a world of murky waters where the smartest and the most organized survive and become successful while the rest are gobbled up. A written plan short circuits our normal response to something as emotional as money. It prevents us from resorting to our gut feelings and emotions. Instead of following the herd mentality that may prompt you to make unwise investment decisions, a plan will force you to stick to a rational strategy that is underpinned by fundamental investment principles. Some of the difficult emotions that you will have to overcome while investing include:
1) The fear of failure
2) The tendency to continue with a certain approach just because you started it
3) Personal matters such as relationship issues at home

It is also important to point out the main reasons why investors fall prey to the market and lose their precious funds:
1) Omitted facts and figures mislead investors into investing in a structurally unsound company or financial instrument
2) Overconfidence makes some investors think that they are invincible and that they can always beat the market.
3) Everyone wants to be seen as a champion, the successful general capable of leading an army to victory. This can make you make investment decisions that are not based on rational thinking but rather the desire to impress your friends, co-workers or family members

By having an investment plan written down and actually following what it says, you will have dramatically increased your chances of winning and increasing the size of your nest egg or investment portfolio. The following are simple steps in creating a plan and avoiding the herd mentality and instinctual impulses that turn us into fools when investing:

1. Set up specific and realistic goals
For example, instead of saying you want to have enough money to retire comfortably, think about how much money you’ll need. Your specific goal may be to save $500,000 by the time you’re 65.

2. Calculate how much you need to save each month
If you need to save $500,000 by the time you’re 65, how much will you need to save each month? Decide if that’s a realistic amount for you to set aside each month. If not, you may need to adjust your goals.

3. Choose your investment strategy
If you’re saving for long-term goals, you might choose more aggressive, higher-risk investments. If your goals are short term, you might choose lower-risk, conservative investments. Or you might want to take a more balanced approach.

4. Develop an investment policy statement
Create an investment policy statement to guide your investment decisions. If you have an adviser, your investment policy statement will outline the rules you want your adviser to follow for your portfolio. Your investment policy statement should:

Specify your investment goals and objectives,

Describe the strategies that will help you meet your objectives,

Describe your return expectations and time horizon,

Include detailed information about how much risk you’re willing to take,

Include guidelines on the types of investments that make up your portfolio, and how accessible your money needs to be, and

Specify how your portfolio will be monitored, and when or why it should be rebalanced.

A smart investor with a written down plan and strategy has already won half the battle without making a single financial decision. By implementing the plan and adhering to laid down rules of operation, the smart investor will avoid the pitfalls caused by human emotion and behavior and end up winning big.

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