19. What are the Risks in Futures Trading?

Designed for students and traders at ATS Academy, this comprehensive guide explores each type of risk associated with futures trading, real-world examples, and how to manage these risks effectively.

Introduction

Futures trading offers the potential for high returns, but it also comes with high risk. These risks arise due to the leveraged nature of the market, price volatility, margin requirements, and market dynamics. If not managed well, futures trading can lead to significant financial losses.

Major Risks in Futures Trading
1. Leverage Risk

Futures allow traders to control large positions with relatively small margins (5%–15% of the contract value). While this amplifies gains, it also magnifies losses.

Example

2. Market Volatility Risk

Futures prices can swing sharply due to economic news, geopolitical events, earnings, or global market movement. Sudden price swings can trigger stop-losses, margin calls, or forced exits.

Example
An unexpected RBI interest rate hike can cause index futures to drop 200 points within minutes.

3. Margin Call Risk

Traders are required to maintain minimum margins at all times. If the market moves against a position, the broker issues a margin call. Failure to meet this call may result in forced liquidation at a loss.

Example
A trader shorting Bank Nifty may face a margin shortfall due to a short squeeze, resulting in auto-square off.

4. Unlimited Loss Potential (Especially for Shorts)

Unlike options buyers, futures traders do not have a capped downside. If the market moves significantly against the position, the losses can be theoretically unlimited.

Example
Shorting crude oil futures at ₹6,500 can result in massive losses if oil spikes to ₹7,200 due to global conflict.

5. Liquidity Risk

Not all futures contracts have sufficient volume. In low-volume contracts, executing trades without slippage can be difficult, and exiting positions may be delayed or costlier.

Example
Stock futures of smaller companies may have wide bid-ask spreads, causing losses when exiting.

6. Basis Risk

The difference between spot and futures prices (called basis) may behave unpredictably, especially for hedgers. This can reduce the effectiveness of hedging strategies.

7. Systemic/Counterparty Risk (Low but Present)

If the clearing house or brokerage platform experiences failure, there is a remote but significant risk of not being able to settle trades or access funds.

Summary Table: Risks in Futures Trading
Type of RiskDescriptionImpact
Leverage RiskSmall move causes large gain/loss due to low margin requirementsHigh financial exposure
Volatility RiskSudden market movement can hit positions or stop-lossesQuick P&L swings
Margin Call RiskCapital must be topped up daily; failure leads to liquidationForced exit, additional cost
Unlimited LossNo cap on loss if market moves sharply against the positionCatastrophic financial risk
Liquidity RiskWide spreads or low volume may delay exits or increase costSlippage, execution delays
Basis RiskHedging may not be perfect due to changing spot-futures relationshipHedging inefficiency
Operational/Systemic RiskPlatform failure, order execution delay, connectivity lossMissed trades, exposure gaps
Real-Life Case: The Leverage Trap

A trader goes long on 5 lots of Nifty Futures (₹22,000) with ₹2.5 lakh capital. The market drops 1.5% in 1 hour.

This example shows how leverage combined with volatility can quickly erode capital.

Risk Management Strategies
StrategyHow It Helps
Use of Stop LossLimits loss per trade
Position SizingPrevents overexposure to one trade
Monitor Margin DailyAvoids margin calls and liquidation
Avoid Illiquid ContractsEnsures better exit and pricing
Understand VolatilityTrade smaller during events or news-heavy sessions
Diversify TradesDon't put all capital in a single index, sector, or stock
Key Takeaways