IntroductionThe derivatives markets serve an important purpose in modern economies particularly in the transfer of risk from those wishing to avoid risk, to those prepared to take risk (in the hope of a substantial return).
Whilst the markets are primarily used by professional investment managers, they often have a great appeal to the part-time investor. Such parties must however, ensure that they enter the markets with their eyes open, as the rewards can be high, but the downside can be equally enormous.Should I get involved?Before getting involved in derivatives, a potential participant must examine their motives for using the products offered. Generally speaking there are four broad categories of market participant.HEDGERS:those who use futures and options to protect an existing portfolio ( or anticipated investment) against possible adverse market movement,ARBITRAGEURS:those who profit from price differentials of similar products in different markets, e.g. price differentials between the spot and futures price of a commodity. Usually only the professionals get involved in this area,INVESTORS:those who use futures to enhance the long-term performance of a portfolio of assetsSPECULATORS:those who use futures for short-term profits, e.g. to "bet" on short-term moves in the market.Clearly futures are very useful tools for those in categories 1 to 3 . They can also be excellent tools for speculators, but the pitfalls are great and the inexperienced must beware.Should I be speculating?On the face of it, the chances of making a profit or loss speculating in futures appear to be equal. In reality, the picture is much more daunting: studies of non-professional speculators trading in futures in the USA show that over 90% lose money.Furthermore, speculating in futures can be more dangerous than speculating in any shares, because of the gearing effect. With shares the most you can lose is what you pay... [continues]
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