Futures contracts are risky because they are highly leveraged instruments. Leverage means that
only a small percentage of the market value of the product
is required as cash in your
account in order to buy or sell the contract. Consequently, a small percentage movement in the price of
a futures contract, say for example, the E-mini® S&P 500® futures, can produce a dramatic percentage change in the level of cash in the trading account, either higher or lower
and even depleting cash altogether. This is true whether day trading or position trading and means that every futures trader needs
to be aware of the magnification effect of leverage and know how to control it.
Trading with and adhering to the rules of a plan, a plan that specifies the futures position exposure appropriate
for your trading capital, will help you to control leverage.
All futures positions can incur loss as a result of the riskiness or unpredictability of market price movements. The futures day trader must therefore
know how to manage the price risk of loss. A common technique for managing this loss is with a stop order.
Say that a day trader just sold a June E-mini S&P 500 contract at 904.75 and doesn't want to risk more than $150 on the trade, not including
commission and fees.
The trader will lose money on the position if prices rise, so they’ll need to enter a stop order to buy at a price
that is above the market price. Since every point in the E-mini S&P 500 is worth $50, the trader will place a stop order to buy
a June E-mini S&P 500 at 907.75 which is 3 points above the sell price ($150/$50 = 3 points). If prices rally to the stop price,
then the position will be automatically closed thereby limiting loss.
The effectiveness of the stop order may be compromised during especially volatile trading periods.
The order may be filled at a much worse price than the trader expected or even, in the event of
gapping behavior, be unabled to be filled. During these times, the day trader should remain attentive so long as the position remains
open or, in the extreme, avoid trading until volatility returns to normal. As well, trading will not be possible if the market moves
to the price limit - circuit
breakers established by the exchange and designed to temporarily halt trading in an attempt to calm markets.
Beyond the price risk listed above, the day trader also has transaction risk such as error in order entry or usage. However,
because day trading is done electronically, the trader has the ability to confirm (or cancel) an order
prior to transmission and this greatly reduces transaction error. The trading software also generates written records associated
with all orders and fills thereby eliminating errors in recording.
Finally, the futures day trader is exposed to the risk of communication failure with the electronic trading platform or even
failure of the platform itself. While the trader has no control over the latter, the former is reduced by brokers who provide
telephone access for their day trading clients. In the event of online communication failure, clients can execute orders by telephone.
The following trademarks and service marks are owned by Chicago Mercantile Exchange Inc.: CHICAGO MERCANTILE EXCHANGE®,
CME E-mini®, CME®, E-mini® and Globex®. The following are trademarks of The McGraw-Hill Companies: S&P®, S&P 500®.