Index Futures Explained

From our new article you will learn:

• why you should use index futures;
• what is a futures index;
• how to calculate a market position; and
• what is leverage

Index Futures

Index futures are a financial instrument allowing you to either hedge your risks or to speculate on the dips or rises of the entire Forex, equities, or commodities market. All derivatives of futures (for example, options) are equally available to both investors with substantial institutional capital and those who only trade a small personal account. The absence of minimum capital requirement is one of the reasons why so many traders with limited funds opt for index futures as they cannot use their traditional alternatives.

What are Index Futures

Index futures is a special type of contract, according to which, instead of delivering a specified amount of currency, commodity, only the difference in price is compensated. By making such a contract, the transaction participant undertakes only to receive or pay the difference in the price of the contract itself. This comes in handy with large contracts on, say, oil as most people don’t really want to have a thousand barrels of Brent Crude delivered to their apartment. The price is determined by the index in the last hour before the close of trading. Due to this, participants can trade the entire market as a whole.

How to calculate a market position

In the futures index contract, it is not always clear how to calculate your market position. To do this, use the following formula: market position size = contract price * current US dollar rate * 2%. This means that if a trader bought a contract at a price of 190,000 euros, then the position size will be equal to only 90,000 euros, and not 190,000 euros. Thia is because the index of such a contract is directly tied to the US dollar.

Leverage

Trading in the futures market, you can use leverage, meaning that a portion of the funds required to make a contract will be borrowed. Leverage is a double-edge sword: it can provide additional profit which can exceed that of standard trading manifold; but, at the same time, leverage increases risks as losses are augmented by the exact same proportion, which may lead to a complete wipe-out of your entire trading account. With this in mind, always be careful when using leverage.

Here is an example of what a 7:1 leverage can do (some brokers provide even greater leverages including but not limited to 50:1). A price change of only 5% is able to provide a 35% increase in the deposit if you were correct about the direction of the market. But if you were wrong, you will lose the exact same amount. So, if you are not prepared to risk a third of your deposit on a single trade, do not use leverage until you grow comfortable and more experienced.

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