buying precious metal futures?

Question

i am planning to invest around $10,000 in silver futures. i dont have to pay commission. i plan on buying during a lull and selling when the price rises about $.30-.40. After this i will have made a very small profit on each ounce of silver but a large profit overall. enough to overcome the cost of the legal fees for trading like this. next, i will buy again when the price of silver drops at least $.30-$.40 and wait to sell when it rises again. following the process, over a period of about a year and a half making trades like this 1-3 times per week. my friend made a model of this and projected that i stand a good chance of tripling my assets over that year and a half. WHATS WRONG WITH THIS AND WHAT RISKS AM I TAKING? IN OTHER WORDS, WHAT CAN GO WRONG WITH THIS PLAN? INCLUDING THE $30-$50 GOVERNMENT TAX ON EACH SALE, WHAT OTHER COSTS AM I UNAWARE OF. this is important because if there are others, i might not make it over the "hump".

key point to remember: the silver market is not like stocks in the respect that silver is never going to drop in price and never return eventually. so, when reading the question, know that if the price drops when i have bought, i can just hold onto the futures until the price rises again and then sell.

a big risk that is present is the liquidity of the market.

Answer 1

First of all, your friends model seems to be making several assumptions.

As several posters said, futures have an expiration date, which means, if you haven't realized that you're profit by expiration, you'll need to either sell the contract at a loss or rollover to a new contract month which will incur additional costs.

Now, silver can move $.30-$.40 cents in a day, which means you'll need to be monitoring the market during the day. Can you do that?

Also, futures are very highly leveraged, meaning a small move can mean huge losses. For instance, the COMEX silver contract is 5,000 oz. of silver. The margin is $4725. In one of your edit's you said Silver will never fall. You mean, never fall to zero, but it does fall. If you bought 1 contract at the beginning of the year, silver was trading at $13.01/oz and by 1/12 dropped to $12.43 per oz. That's a $.58 loss per oz. or $2900. Actually, from early Dec. 2006 to 1/12, silver dropped $1.62/oz. or a total loss of $8,100 ($1.62 x 5000 oz.) which means you would have been hit with a margin call. Maintenance margin is $3,500, meaning you'd havet to put up an additional $3,500 to maintain the position or you'd be closed out.

What your talking about can be done, BUT you either need to be a day-trader with direct floor access (meaning you need to be sitting at your computer screen and have direct access to the floor broker to execute the trade quickly as if you do not, that $.30-$.40 profit could evaporate quickly in the time the order is filled) or you need to be a pit trader.

How you got past not having to pay comissions is interesting, since that's how the brokers make their money.

Anyway, what you're proposing isn't as simple as you think it is. It can be done, but if you're an off floor trader, you'll need real time data feeds, high speed access directly to the floor to make the trade, etc. But, really to do something like this, you need to be a pit trader, which means you'd need to buy a seat on the exchange in question and that can run upwards of $250,000 or more.

Also, there is a learning curve as you'll need to become so intuned with the silver market that you know when prices are going to turn. I have a friend that is so intune with the sugar market that he knows the characteristic of the market so well that he can see turning points coming based on price action and market behavior - but it took him years to become that intune with it.

What you are proposing is more or less scalping the market. Can it be done? Yes, but it's not going to be as easy as you think it is.

I'll give you an example of what can go wrong. You have $10,000. At current margin requirements, even 1 contract puts you at 47.25% of your account equity - not good. In futures, you should never commit more than 5% of your account equity to a trade, so to propose what you're doing, you'd really need an account of about $100,000. But, you only have $10k, so you purchase 1 Feb. 2007 silver contract at $12.55 (what it's trading at now). Good news comes out that causes the dollar to rally strongly thus pushing precious metals prices down and silver drops $1.45 over the next several days to $11.10 (which is highly possible as silver as recently as Oct. 2006 was in the $11 range). You lost $7,250, you'd be hit with a margin call because there'd only be $2,750 left in your account. If you have margined 2 contracts (which would be insane with a $10k account), a $1.45 loss would wipe out your account and you'd need to come up with an additional $4500 to make up for the shortfall.

Like I said, what you're proposing can be done, but you really need to be aware that it's not going to be as easy as you think and you really need to be monitoring your position constantly. You'll need direct floor access (preferably electronic trading as opposed to the open outcry method) or in the pit yourself.

If you do indeed decide to go this route, I would suggest you do it with the mini-silver contracts (1,000 oz.).

Futures are not ranked as one of the riskiest investments for nothing. If you look at your friends model, he's probably only computing consistent gains. What he has failed to take into consideration are losses and equity drawdown.

In my opinion, what you're poposing (scalping) is best left to the pit traders.

Answer 2

The question is how do you know the price will rise? Hopefully you're a proficient technical analyst. I know commodities are not like stocks but this doesnt mean they will keep rising in price. In fact, many investors are claiming the metals bull market has come to an end. Furthermore, you cant never be sure if the price of the commodity will fall 5% before it rises 4% or even worse. Some people think commodities are much more secure than stocks because they're more liquid and therefore are less volatile. This is not true, as the most recent case at the beginning of this month when silver suffered a 10% decline in only 3 days. Or in early september of '05 when it lost 20% of its value in less than 2 weeks!. As you can see silver has failed to recover the losses from september, if you had invested your money at that time hoping to ride it until you get a 4% gain you would still be waiting. Your strategy is nothing new, its something commonly done by swing traders but even they can tell you it is not as simple as you make it seem, your trades wont always rise, you will have many losses, having a profficient knowledge of technical analysis cuts some of those losses. Unless you know about swing trading and technical analysis I think your strategy is a not a good idea.

Answer 3

One thing I noticed as the risk from what you have written is 'the price of silver never drops and never will rise' and you strategise to hold it till the price rise once having bought into futures. This means that the futures can expire without the price having really risen which can be a risk. You cannot hold onto a futures contract for eternity, it has expiration dates on which date you will have to fulfill the contract unless it is like a LEAP option where you can contract long term expiries. Study the silver market carefully try to get hold of when the price moves up after it has come down and depend on it to make trades which will be a more educated way of investing. If your friend has tripled the investement in and year and a half then probably it will work that way. Then your assertion that once the price come down it won't rise again is not very reliable to answer this question.

Answer 4

Are you in the US? There is no tax here until year end.
The problem is that it will move far enough away from you that you will become convinced that it is not coming back, or, if you figure if I knew it was going down 5$, I should have taken a small loss.
Also with futures, there is a month of delivery. You have to put in cash to make up for losses, since you only make about a 1% deposit. Silver moves 1% and you've either doubled your money or lost it all. Playing with real money is not as rational as pretend.

Answer 5

You are aware futures expire, right?

If you buy silver today at $1.00 and you hope it will go up by $0.30 in the future and it does not.

YOU CANNOT WAIT FOREVER UNTIL THE PRICE IS UP AGAIN.

In that case you will lose your money.

Unlike ETFs. You cannot just hold your silver until the price is up again.

If you cannot sell your future contract before the expiration date (And nobody will buy your contract if the price is actually higher than the market price) you will lose 100% of your contract cost.

With enough futures in the wrong direction you will lose all your money very quickly.

At least with ETFs you can hold your silver for a while hoping it will go up in the future.

With futures you cannot wait that long.

It seems you really need to go back to the drawing board with your plan.

Also $10,000.00 is too little to invest it in the futures market.

Answer 6

how could a person double or lose all of their money on a 1% change in price? seems to me the person would either lose or make 1% of their investment. To double or nothing a 100% change would need to take place, which is very unlikely in the commodities market. I don't see any risk of losing all your money unless you are stupid enough to continue to not quit after several losses.

Answer 7

Welcome, sardine, to the world of sharks!

If everyone had this plan, would EVERYONE make money and not lose a dime? I doubt it.

The problem with this and every other investment plan is GREED and FEAR. You get greedy, you get slaughtered. You get fearful, you get slaughtered.

Why is it that when I buy a stock after it after a $1 dip, knowing it's a good company, then why is it I don't sell it and make a profit next week when the rumors are proven false?

Investing your only $10K in this plan is not only fraught with extreme risk, but, hey, it's your money.

"When two people meet, one with knowledge and one with money, they soon part company. The one with the knowledge has the money, and the one that had the money gets the knowledge."

WealthBuilder

Answer 8

What makes you think precious metals will increase in value? They haven't kept up with inflation in the past and won't in the future.

Answer 9

THATS WHAT THE HUNT BROTHERS SAID IN 1970'S WHEN THEY LOST OVER A BILLION DOLLARS.....

TOOKING A WACKING AND NEVER CAME BACK..........

10G IS SMALL INVESTMENT.
AT ALMOST 7.00 OUNCE..

WON'T MAKE 500.00 YEAR FOR ALL THAT LABOR AND TROUBLE..
AND THEN HOPE MARKET STAYS UP AND DOES NOT DROP BACK TO 4.50 AN OUNCE..
YOU TAKE A LOSS THEN.......... OF 2.50 AN OUNCE AND BE YEARS BEFORE IT BOUNCES BACK.

Answer 10

Just buy gold