To set up a futures account, investors must provide margin. Margin in the futures markets is defined as the money that buyers or sellers of futures contracts must deposit with their brokers to ensure contract performance. Minimum margin requirements are set by the commodity exchange, but individual firms can set them higher. If the price fluctuations of a contract held by a customer result in a loss, additional margin must be deposited. This is called a margin call. If the price of a contract results in a profit, money can be withdrawn.
Before you start trading, take the following precautions:
1. Follow a trading plan. Whether you favor technical or fundamental analysis, or a combination of the two, devise a strategy and stick with it.
2. Don't trade with money you can't afford to lose. While you don't have to keep extra cash in your trading account, you should have at least double the required margin available in case you need it to satisfy a margin call or take an additional position.
3. Don't put all your eggs in one basket. Successful traders minimize their risk by spreading out their trades in several situations over time.
4. Don't expect your trading profits to pay your living expenses.
No matter what your level of expertise, commodity trading can't be reduced to an exact science with predictable results. The idea is to avoid big losses and be right enough of the time to make your trading profitable.
Think you're ready to trade? Pretend you're a pilot taking off, and check that all systems are go before leaving the ground:
- Analyze the fundamentals to decide where the best possibility of profit lies.
- Weigh risk against return, and don't take a big risk for a small return.
- Timing is everything, so use your technical charts to determine if the time is right to enter the market.
- Have a clear-cut view of the market's trend before you initiate a long or short position.
- Don't try to anticipate a trend. Wait for one to develop; then take a position.
Futures trading is speculative and risky, and because there is no assurance that it will be profitable, it is not appropriate for everyone. Only risk or hedge capital should be committed. If you can't live without it, don't put it in the futures markets.
Lorayne Fiorillo is a financial advisor at Prudential Securities Inc. Past performance is no guarantee of future returns. For more information, write to Lorayne in care of Entrepreneur, 2392 Morse Ave., Irvine, CA 92614.