I recently saw the following post on an investment forum. I thought it would be an interesting topic for my newsletter. So here is my long answer:
Question: Is the risk factor of investing in commodity futures greater or lesser than that in funds?
Answer: Generally speaking the risk of trading futures is greater than investing in funds. I stress the word “generally” here as futures are not riskier all of the time.
Consider trading in futures versus investing in Madoff’s fund. Before the scandal broke, pretty much anyone would agree that investing in futures would be riskier. In hindsight of course, the opposite is true.
Scandal and fraud aside, there is the issue of control. With trading futures (or actively managing your own investments of any type), you have control of what you money is doing. One reason I have never been a fan of managed funds is you really have no idea what the individual manager is (or managers are) actually doing day to day, except maybe in hindsight.
If you are invested in a fund, your money is also at risk of key staff leaving or taking leave. All funds will have ways of dealing with this, but it is still a risk to the investor.
With futures you know where you money is at all time, because you control it.
Another issue is flexibility. With futures you are free to buy and sell whenever the market is open. This way you can adjust you market exposure virtually instantaneously. Some funds have limitations on when you can take your money out, waiting periods and so on. Not having flexibility is a risk.
Another point relating to risk of futures trading is that risk is very much dependant on how you go about trading futures. A statistic you’ll often hear in books on futures is 80 to 90 percent of people lose trading futures.
I cannot say whether or not that number is true, but in my own past experience as a broker, trader and adviser, I have seen a lot of people lose money because they approached trading without a plan or without the right information.
I have never flown a helicopter and I bet if I tried without the proper lessons and tools, it would be a short lived hobby. The same goes with trying anything new including trading futures. You need the right tools and the right approach.
What tools and what approach? The answers to these vary from person to person. I started out trading outright futures positions, and then I moved into options. I’ve even written a few books about options trading. I love the flexibility of trading options. You can create any type of position you like once you know how to.
I also trade futures “spreads”. That is, I trade the value of one futures contract versus the other based on certain information. I have found this style of trading to be significantly less risky than trading outright positions. Plus, it is in fact one of the more reliable trading methods I have come across.