Peter Gratton, M.A.P.P., Ph.D., is a New Orleans-based editor and professor with over 20 years of experience in investing, risk management, and public policy. Peter began covering markets at Multex (Reuters) and has expanded his coverage to include investments, ethics, public policy, and the health and travel industries.
Updated March 14, 2024 Reviewed by Reviewed by JeFreda R. BrownDr. JeFreda R. Brown is a financial consultant, Certified Financial Education Instructor, and researcher who has assisted thousands of clients over a more than two-decade career. She is the CEO of Xaris Financial Enterprises and a course facilitator for Cornell University.
Part of the Series Guide to Futures TradingIntroduction to Futures
Overview of Futures Products
How to Trade Futures
Futures Trading Considerations
A tidal wave of new trading has flooded the futures market, sparking fears that many are taking on catastrophic risks they don't understand. Futures trading grew almost one-and-a-half times in the previous decade to 29.2 billion contracts in 2023. This boom has been helped by individual investors—who make up about 10 to 15% of the futures market in the U.S.—looking to hit jackpots in the complex derivatives market. Regulators have been scrambling to warn retail and other investors about the potential losses facing those who trade in the futures market.
Fortunately, we now know far more through recent studies about the risks retail investors, in particular, face in this market. To help us unpack this research and figure out how risky futures are, we spoke with Scott Mixon, Ph.D., acting chief economist, and Alex Ferko, Ph.D., research economist, at the Commodity and Futures Trading Commission (CFTC). Along with Esen Onur, another CFTC economic researcher, they produced a February 2024 CFTC study that provided unprecedented insights into retail traders in futures. We also spoke with Jack D. Schwager, a leading expert on futures and bestselling author of the "Market Wizards" book series. While this article centers on the risks facing retail futures traders, we'll discuss the broader futures market while learning what both researchers like Mixon and Ferko and practitioners like Schwager can tell us about how risky the market is for those trading futures.
Before touching on their risks, let's first set out what futures are and why they matter. Futures are financial contracts that commit buyers and sellers to transact an underlying asset at a preset price on a specified future date. They play a critical role in finance and the economy as tools to manage uncertainty in commodity production, financial markets, and other areas. "Futures benefit everybody," Schwager told us. "The future markets provide a hedging vehicle so people, corporations, farmers, or even investment groups can reduce their risk in cash assets."
You can buy futures that cover commodities, financial securities, weather events, shipping rates, electricity, telecommunications bandwidth, real estate, and even political elections. Equity index futures are the most actively traded, accounting for 65% of volume as of 2024, followed by currencies and interest rates at 9%, and agricultural and metal futures at 5%.
The traditional and most popular use for the futures market is for hedgers seeking to mitigate price risks. Major hedgers include farms, commodity producers/consumers, banks, and asset managers who would like to lock in prices in the future and reduce uncertainty.
For those who hedge with futures, Schwager said, these contracts "allow them to operate more efficiently, which has a clear economic benefit." For example, an airline might buy oil futures when prices are low to hedge against spikes in jet fuel expenses. These hedgers offset risks in their operations that could significantly swing revenues and expenditures if left unprotected from volatility. Futures provide stability in a world where prices are not.
While speculators are often depicted in hostile terms, Schwager says they are necessary for the futures market. "The benefit of speculators is very simple: somebody has to be on the opposite side of those trades [for hedgers]. And there has to be a lot more trading going on than just large commercial" entities hedging for the future. Speculators range from retail traders to hedge funds.
"It's easy to lose money [in futures]," Scott Mixon, the CFTC's acting chief economist, told us bluntly. "Traders should really understand what they're doing."
Let's unpack the forms of risk involved in futures and then compare them to those of other financial assets:
Basis risk: This is the chance that the price of the futures contract doesn't move the same way as the price of the asset. This means that even if your predictions play out with the prices for the underlying asset, you might not make out as well as expected.
Leverage risk: Futures provide leverage because they allow traders to enter into a position by putting up only a small percentage of the total contract value rather than its full cost. But leverage is double-edged. If prices move even slightly against the leveraged futures position, substantial losses can quickly accrue.
Liquidity risk: Some futures contracts, especially those with longer expiration dates or for less commonly traded commodities, may have less liquidity. This can make it difficult to enter or exit positions at the desired price, increasing the risk of slippage. This problem was more common before trading was digitized.
Market Risk: The most obvious risk with futures trading is that prices can be highly volatile, and changes are can be swift, adverse, and devastating. This is because the market risk is magnified by leverage, when there's already enough to worry about when supply and demand shift.
Regulatory risk: Changes in regulations or tax laws can impact the futures market. Traders need to stay informed about potential changes that could affect their trading strategies or the profitability of their trades.
To better understand the risks in futures, we need to compare them with other popular investments. However, let's make it unmistakably clear that much depends on the trader's experience, the underlying asset, the market backdrop, and more. That said, generally speaking, futures trading is often considered riskier than stock trading because of the high leverage and volatility involved that can expose traders to significant price moves.
Below, we compare the relative risks of these investments with the caveats noted above that can shift these simplified assumptions.
| The Relative Risks of Futures, Options, and Stocks | |||
|---|---|---|---|
| Risk Factor | Futures | Options | Stocks |
| Leverage Risk | High (long and short) | Moderate (predominantly long) | Low (predominantly long) |
| Market Risk | High (long and short) | High (long and short) | Moderate (long and short) |
| Liquidity Risk | Low-moderate (long and short) | High (long and short) | Low (long and short) |
| Risk Duration | Limited because of expiration (long and short) | Limited because of expiration (long and short) | Long-term hold mitigates risk (long) |
| Buyer Risk | Potentially unlimited losses (long) | Limited to premium paid (long) | Initial investment (long) |
| Seller/Writer Risk | Potentially unlimited losses (short) | Potentially unlimited Losses (short) | Potentially unlimited losses (short) |
| Complexity Risk | Moderate (long and short) | High (long and short) | Low (long and short) |
Unlike commercial hedgers offsetting offset business risk, retail speculators voluntarily take on the price risk, enticed by the potential for outsized returns. Retail investors are generally defined by the CFTC as those with 50 trades a day or less, though specifying what's meant by the term proves tricky given the different definitions among market participants, as a 2022 World Federation of Exchanges (WFE) study analyzing their poll of exchanges showed.
Although participation in the futures market has grown exponentially, we shouldn't oversell retail traders' impact on the wider market. Retail numbers might spike the trading volumes, but much of the investment capital involved has long been from relatively few players, Ferko and Mixon said. "When we think about the bulk of the market and the commitments of traders, it's literally like 500 traders or 1,000 traders that we think about—they make up about 90% to 95% of that open interest." Still, Ferko added, retail investors are "sometimes the majority or a large fraction of the accounts actually trading."
Just because their trades are smaller doesn't make it less essential for stakeholders to safeguard them in the market. "For that individual, it might be 100% of their portfolio [at stake]. So we have to be mindful. For them, it's the full $1,000 of margin they have. That's the case for thousands of customers."
A dearth of data about retail trading has long been a problem for anyone looking at futures trading. Commitments of traders futures data primarily captures large institutional traders. "Below that [size] threshold, everything is left as a residual. It's just like, 'Here are some other people trading,'" Mixon said. This meant that regulators didn't have much visibility into the behavior and outcomes of retail investors.
Before the 2024 CFTC study, one of its authors said, "The only paper we've seen where you really had raw data on these smallest retail futures traders—it's almost literally 100 years old."
Fortunately, Mixon, Ferko, and Onur obtained recent account-level margin and position details initially collected for another purpose. Earlier CFTC research highlighted shifts in how futures are traded, raising worries that investor risks were growing. In the past, the market was dominated by major corporations hedging prices, but high-speed algorithms and a wider range of participants, including intermediaries like hedge funds alongside commercial hedgers, now trade futures. Regulators and researchers, including those at the CFTC, have been working to find out what this changing landscape means for traders large and small.
Ferko and Mixon's data concerned margins and positions for over 36,000 individual retail accounts from 2021 to 2022. (They say the year isn't an outlier and should be taken as representative of present trading.) It's worth noting that in most studies, retail investors, by definition nonprofessionals, don't come off as very astute. For example, the WFE analysis found clear patterns mentioned by the exchanges that saw significant differences between retail and other investors: retail investors trade in round numbers, overreact to volatility, and engage in herd behavior. The WFE also suggested that retail investors tend to trade too late, moving in light of volatility or news of stocks and derivatives going up after the market has already priced in any profits to be had. This may be due in no small part to a lack of knowledge. A 2022 Financial Industry Regulatory Authority study suggested the typical investor could correctly answer less than half the 10 questions in a basic investment knowledge quiz, with almost half answering "that the past performance of an investment is a good indicator of future results."
In line with the WTF analysis and previous research, Mixon and Ferko said that retail investors tend to behave as contrarians (though perhaps not on purpose), buying index futures when net buying is down, selling less than others when the trend goes the other way, and acting on loss aversion biases.
Their study also reveals how retail investors tend to trade futures in short bursts. These individuals lost money trading futures on average, with the median estimated losses ranging from $100 to $200 per event. While 40% of traders ended up profiting, the larger average losses outweighed the smaller average gains. The median retail investor had four separate trading "events" over the sample period, with the typical trader exiting the market for a week before reentering. Their trades concentrated on benchmark equity index micro-contracts like the Micro E-mini S&P 500. The median account maintained less than $4,000 in margin at any given time. Many retail traders, they show, are one-and-done. "We found evidence that bigger dollar losses on the first trade are significantly associated with leaving permanently," Ferko said.
The study highlights the challenges retail traders face, but it has limits. The researchers only had access to data for overnight futures trading, not day trading. "We're certainly looking to expand on this. . We think there's definitely information we can get there" that would give them the full view of retail trading, Ferko said.
Caution signals for retail investors are throughout these recent analyses. The WFE's researchers concluded, "Without minimum levels of financial literacy and education, retail investors may be easily driven into misleading investment strategies. If lacking adequate protection, investors may fall victims of financial scams."
For years, CFTC researchers have suggested two potential policy improvements to aid retail traders in futures markets:
Nevertheless, not much can protect investors from being over their heads. "If traders don't have the proper skills, they could easily lose," Schwager said. "But it's their freedom of choice, and speculating is choosing to participate."
Risk management is crucial in futures trading to protect investments and ensure long-term success. It's "more important than their particular approach in trading the markets, and that's something that retail investors and other traders don't really understand," Schwager told us. Here are the essentials:
Diversification: Traders can spread their risk by diversifying their investments across different futures contracts or asset classes. This reduces the effect of any single market movement on the overall portfolio.
Education and research: Staying informed about market conditions, economic indicators, and other relevant factors can help traders make more informed decisions and manage risk more effectively. This was a point that Ferko, Mixon, and Schwager all emphasized when speaking with us.
Hedging: Hedging involves taking a position in a futures contract opposite to a position held in the underlying asset. This can help protect against adverse price changes in the underlying asset.
Options: A more advanced move is buying put options on futures contracts. This can offer downside protection while still allowing for gains.
Position sizing: Traders should determine the appropriate size of their positions based on their account size and risk tolerance. This helps prevent any single trade from causing significant damage.
Regular monitoring: Futures markets can be volatile, so traders need to monitor their positions regularly and adjust their strategies as needed.
Risk-reward ratio: Traders should always be mindful of the potential reward of a trade relative to its risk. A favorable risk-reward ratio can help ensure that potential gains outweigh potential losses over time.
Stop-loss, limit, and trailing stop orders: Schwager said these are a trader's first and best line of defense when trading futures. A stop-loss order is an order to sell a security when it reaches a specific price. This can help limit losses on a position if the market moves against you. You can also employ a limit order to buy or sell a security at a specific price or better. This can help traders control the price at which they enter or exit a position. There are also trailing stops, which are stop-loss orders that move with the market price.
Retail traders face unique challenges in the futures market. So, in addition to the above important risk management strategies, here are 10 equally essential risk management moves:
An additional point is well worth making. For some retail traders, trading apps, especially for newer vehicles marketed explicitly to them, can look indistinguishable from the sports betting apps that many also have. If you find yourself mentally thinking of your trades as bets or your volume of trading is outsized (initial test: how often do you look at your phone app?), it's time to step back. Also, it's best to avoid "gamblified" (an intensification of "gamified") investments. The Securities and Exchange Commission has started tightening regulations on this, but futures trading falls under the CFTC. A 2022 study defined a gamblified investment as follows:
Yes, it is possible to lose more money than you initially invested in futures trading. This is because futures contracts are leveraged, which means you can control a large position with a relatively small amount of investment upfront. While leverage can amplify your gains, it can also magnify your losses.
Some futures traders are self-directed and passionate about markets, while others are professional traders working for institutions and the education to match. Regardless of their background, they share a deep understanding of technical and fundamental analysis, have well-defined trading strategies, and rigorously manage their risk.
To calculate profit and loss in futures trading, you need to consider the difference between the price at which you entered the contract and the price at which you exited or plan to exit it. Here's the formula:
Profit or Loss = (Exit Price - Entry Price) x Contract Size x Number of Contracts
So, if you bought one contract of a futures market at $1,000 and later sold it at $1,050, and each contract represents 100 units, your profit would be $1,050 - $1,000 x 100 = $5,000.
A common rule of thumb in futures is to risk no more than 1% to 2% of your trading capital on any single trade. This means that if you have a $50,000 trading account, you should aim to risk no more than $500 to $1,000 on a single futures contract.
The promise of leveraging futures contracts to control a large dollar amount of an underlying asset is attracting many more people into the futures market. This leverage comes with risks that you don't have with investments, but there are stop losses and other techniques to manage them well.
Recent research shows that retail traders tend to lose money in normal times and panic sell when volatility strikes. Those with the patience, discipline, and risk management skills this area of finance demands are more likely to stay afloat long enough to have success. However, the research also shows that if you don't have these skills, the prudent choice would be to watch the currents of the futures market from the safety of the side lines.