By Myra P. Saefong, MarketWatch
SAN FRANCISCO (MarketWatch) — Futures have a checkered past.
The futures market is often seen as a casino, a legal betting parlor for speculators of the kind portrayed in the 1983 movie "Trading Places."
Futures are speculative, leveraged instruments and aggressive traders can lose big, but these derivatives also can be prudent ways to diversify portfolios and hedge against losses in volatile markets.
Commodities, stocks, Treasury bonds, global currencies — even the weather — are among the many types of investments tied to futures. Buying and selling takes a high level of sophistication, and that's why futures are mostly a tool for institutions, hedge funds, trading firms and wealthy investors.
At the same time, opportunities for mainstream investors to tap the futures market are more present than ever. Now anyone with a brokerage account can climb into virtual trading pits or invest in mutual funds and exchange-traded funds that use futures strategies. In addition, more financial advisers are employing futures to give clients exposure to alternative assets with differing characteristics from stocks and bonds.
Futures are "the fastest growing financial investment sector in the world," said James Mound, head analyst for Moundreport.com, a futures-trading newsletter, and chief of James Mound Marketing Group in Palm Coast, Fla.
What to watch for:
Futures are a way to profit from securities' short-term price movements and trends, both up and down, without actually owning the underlying asset. A futures contract gives you the right to buy a certain commodity or financial instrument at a later date, and you agree to keep that promise.
The main advantage of a futures contract is that you don't have to lay out as much money as you would to own the physical asset. Buying 200 shares of a Standard & Poor's 500 Index fund at $100 a share would set you back $20,000. In contrast, two S&P 500 futures contracts — equivalent to 200 shares of the index fund — would cost a fraction of that due to the leverage involved.
To trade futures responsibly, you must understand leverage and its potential to boost or bust your investment. Clear and concise explanations of futures contracts' risks and rewards can be found at the Web sites of two agencies that oversee futures trading: the federal U.S. Commodity Futures Trading Commission, at www.cftc.gov, and the self-regulating National Futures Association, which polices member firms, at www.nfa.futures.org .
You'll also learn about margin — money you must keep in the account to cover losses. Margin requirements fluctuate, and if a trade goes against you a broker may require you to pony up more cash in what's known as a "margin call."
These two governing bodies can also assist in the search for a registered trading firm with experience and a clean record. Enter the firm name, or broker's name, to see the entire licensing history, red flags, problems and complaints.
Once you've vetted a firm, you'll need to ask some hard questions before opening an account, says Nell Sloane, owner of Capital Trading Group.
Get details about the firm's fee structure and any benefits for being a client, along with how much money you'll need to make meaningful trades, Sloane adds. And if you're not prepared to trade on your own, consider specialized mutual funds and ETFs.
Rydex Managed Futures Fund, /zigman2/quotes/205440379/realtime RYMFX 0.00% for example, is an offering from a company that's well-versed in leveraged and alternative investment products. The portfolio is based on the S&P Diversified Trend Indicator, a benchmark for 14 sectors that allocates 50% to commodities such as livestock, grains and energy, and 50% to foreign currencies and U.S. Treasurys.