Margin and Leverage for Futures Trading (2024)

One of the big advantages of trading in the futures markets is its increased liquidity and simplicity, especially compared to operating directly in some of the commodity markets. As a result, many successful traders prefer to trade futures contracts over their underlying assets.

Another reason futures trading can be attractive and lucrative for those with a good trading plan involves the ready availability of margin trading. This feature lets you deposit only a fraction of the future contract’s value as margin to establish and control a leveraged trading position.

The leverage you can use in the futures market depends on the underlying asset involved and the amount of money in your trading account. In this article, Benzinga explains how margin and leverage work in the futures market and how you can use these tools to your advantage.

Margin Trading for Futures

Leverage trading futures allows traders to control significantly larger positions with a fractional cash deposit called margin. Leverage is usually expressed as a ratio, while margin is usually expressed as a percentage.

Futures brokers generally require that traders deposit up to three different types of margin to operate in the exchange-traded futures market. They are:

• Initial margin: All traders need to make an initial margin deposit to operate in the exchange-traded futures market that ranges from 5% to 10% of a futures contract’s value. This initial margin deposit does not represent a partial payment for the futures contract but instead a good faith deposit made to the futures clearinghouse through your broker to secure those parties against trading losses you might incur. Unlike margin trading in the stock market where a stockbroker extends a loan to traders for their margin requirements, no loans are made and no interest is charged to operate in the futures market on a margin basis.

• Maintenance margin: If you hold a futures position after the market closes, then your broker will require you to deposit an additional margin amount called maintenance margin. To hold a position overnight in the futures market, you must deposit a maintenance margin amount that is typically 80% to 90% of the initial margin requirement.

• Day trade margin: This type of margin is set by the futures broker and applies only to futures positions opened and closed during the trading day. If a position is not closed by the end of the trading day, then it typically gets marked to market, and maintenance margin rules are applied.

Keep in mind that using leverage when trading futures contract acts as a double-edged sword. In the same manner that your profits increase through leveraging your futures positions, your losses will also increase by the same amount if a trade goes against you. Some useful tips for using leverage in your futures trading include:

Don’t Trade With Money You Can’t Afford to Lose

Trading leveraged futures contracts can be risky, and you could lose your entire stake faster than if you did not use leverage. Make sure you don’t trade futures with money you can’t afford to lose.

Many people who begin trading futures lack an appropriate understanding of the concept of leverage and the enhanced financial risk involved in using it. They consequently lose more money than they expected or can comfortably afford, which in turn causes them to become discouraged and stop trading futures altogether.

Trade With a Plan

Trading any asset or derivative financial product like a futures contract without a plan can be compared to traveling without a map or a destination in mind. Developing and implementing a trading plan that incorporates a tested futures trading strategy before you begin to risk your hard-earned money makes perfect sense, especially if you plan to trade futures contracts on a leveraged basis.

Once you’ve developed a futures trading plan, you can probably test it via an online broker’s demo or practice account. These accounts are great for practicing since they involve no financial risk. Demo accounts also allow you to gauge a broker’s offerings and services while trading futures in real-time in an account funded with virtual money.

Social trading is another option if you’re new to futures trading and have yet to develop a profitable trading plan. A number of online brokers allow you to copy other traders’ trades into your own account. This practice can facilitate the development of your own trading plan.

Use Prudent Money Management Techniques

Managing your futures trading positions by implementing prudent money management techniques can keep you in business and cut your losses considerably, especially when leveraging your futures positions.

As any professional gambler knows, making it through a series of losses without losing your entire stake means you can continue to operate another day. Accordingly, you can use only a small percentage of your account’s funds for any given position relative to the balance in your account to help your account withstand a string of losses.

If your entire account is instead leveraged in just one large futures position, then you risk going out of business quickly.

Don’t Overtrade

One of the most common errors made by new futures traders is overtrading. Trading futures can be exciting, and inexperienced traders often increase their trading activity when they have turned a profit on a trade.

Overtrading can cause them to risk the profits already made by establishing more, and possibly less successful, positions in the market. Even when a trader has benefitted from a string of profitable trades, they sometimes continue trading excessively. This choice can cause them to end up riding their initial trading profits into losses on the additional trades.

You can jeopardize your trading account by overtrading, so this pitfall should be avoided if you’re serious about making money trading the futures markets. One way to avoid overtrading is to specify rules in your trading plan that help prevent you from making more than a set number of trades per day.

Another issue with overtrading is the increased futures commission costs that this error invariably results in. Even if you initially show a small profit on one good trade, you could run that gain into a loss from the excessive commissions you will need to pay if you subsequently make an unnecessary string of mediocre trades.

Cut Your Losses

A well-known quote about financial markets trading goes as follows: “It isn’t what you make trading, it’s what you don’t lose that’ll keep you in business.” Cutting your losses on a losing position promptly helps avoid worse losses down the road.

While profits tend to take care of themselves and will not damage your business, losses can grow considerably if you stubbornly insist on holding onto a losing position instead of cutting your losses when prudence dictates you really should.

Cutting your losses on a futures trade that starts to lose money can be accomplished by having a stop level firmly in mind while watching the position closely. You can also place protective stop-loss orders with your broker when you initiate a trade or if you need to sleep or focus on something else.

When placing stop loss orders, take note of certain levels on the futures charts where other stops may also be placed strategically. When a substantial volume of stop orders accumulates at a particular level, it can often be targeted by large traders who aim to push the market to that level to get extra profits before the market’s overall trend resumes.

When to Use Leverage to Trade Futures

Most experienced futures traders use leverage to maximize their returns. With that noted, some instances exist where it may be more beneficial to use leverage than others. These include:

• Major market top or bottom: When you have identified a major market top or bottom with relative certainty, you may want to use leverage to increase your trade’s profitability if your view turns out to be correct. In this situation, trading futures with a trailing stop often makes sense.

• Consistently trending market: If the futures market appears to be trending in a well-defined general direction and in a relatively consistent manner, then you could benefit from that fairly predictable ongoing directional movement by leveraging futures positions taken in the direction of the trend to boost your profits further.

When to Avoid Leverage/Margin Trading

Certain situations do not require leveraging at all, while some market conditions can make using leverage risky. These include:

• Uncertain market conditions: You may want to avoid leveraging futures trades done in an especially uncertain or fast market that involve taking more risk. Many futures brokers will even discourage futures trading during highly uncertain market conditions by raising their margin requirements. Because of the extra risk involved, seasoned traders often avoid trading in such market conditions altogether.
• When hedging an underlying asset: If you operate in the futures market to hedge physical assets you own by selling futures contracts against the assets, then you would usually be better off selling the contracts in a cash account instead of a margin account. When the futures contracts approach their delivery date, you can then decide whether to deliver the physical assets into the futures contract or cash out your futures contracts by purchasing them back before the last trading date ends.

Compare Margin Trading Brokers

If you want to start using leverage by trading futures contracts on margin, then you will generally need a futures broker that supports margin trading. Benzinga has taken some of the guesswork out of finding a good futures broker by creating the following list of top futures brokers that allow margin trading.

Frequently Asked Questions