Access to a Wide Range of Markets
Micro futures provide traders with access to a wide range of markets. This allows them to diversify their portfolios across different asset classes. The CME Group offers micro futures contracts on a variety of assets, including equity indexes, commodities, and currencies. For example, a trader can use micro futures to trade the S&P 500, the Nasdaq 100, the Dow Jones Industrial Average, and the Russell 2000. They can also trade commodities like gold, silver, and crude oil. In addition, they can trade currencies like the euro, the yen, and the British pound.
This access to a wide range of markets allows traders to build a diversified portfolio. A diversified portfolio is one that is invested in a variety of assets that are not perfectly correlated. This can help to reduce the overall risk of the portfolio. For example, if the stock market is down, the price of gold might be up. By holding both stocks and gold in their portfolio, a trader can reduce their losses during a stock market downturn.
Micro futures make it easy to diversify a portfolio. The low cost of entry and the small contract size allow traders to take positions in a variety of different markets without committing a large amount of capital. This is a significant advantage for small traders who may not have the capital to trade standard futures contracts.
Cost-Effective Diversification
Micro futures are a cost-effective way to diversify a portfolio. The margin requirements for micro futures are much lower than the margin requirements for standard futures. This means that a trader can take a position in a micro futures contract with a smaller amount of capital. For example, the margin for one Micro E-mini S&P 500 (MES) contract might be $1,200, while the margin for one standard E-mini S&P 500 (ES) contract might be $12,000.
This lower margin requirement makes it possible for a trader to take positions in multiple micro futures contracts across different asset classes. For example, a trader with a $10,000 account could take a position in one MES contract, one Micro Gold (MGC) contract, and one Micro Crude Oil (MCL) contract. This would give them a diversified portfolio of stocks, gold, and crude oil. The total margin required for these three positions would be around $3,000, which is well within the trader's account size.
The ability to diversify a portfolio at a low cost is a major advantage of micro futures. It allows small traders to enjoy the benefits of diversification without having to commit a large amount of capital. This can help them to reduce their risk and improve their long-term performance.
Worked Trade Example
A trader has a portfolio of stocks that is heavily weighted towards the technology sector. They are concerned about a potential downturn in the technology sector and want to hedge their portfolio. They decide to use Micro E-mini Nasdaq 100 (MNQ) futures to hedge their position. The MNQ contract has a multiplier of $2 per point.
The trader's portfolio is worth $50,000. They want to hedge 50% of their portfolio, which is $25,000. The Nasdaq 100 index is currently trading at 12,500. The notional value of one MNQ contract is $25,000 (12,500 * $2). The trader decides to sell one MNQ contract to hedge their portfolio. They sell one MNQ contract at 12,500.*
The Nasdaq 100 index then falls by 500 points to 12,000. The trader's stock portfolio loses 4% of its value, which is a loss of $2,000. However, their short position in the MNQ contract has made a profit of $1,000 (500 points * $2/point). The net loss on the trader's portfolio is $1,000, which is half of what it would have been without the hedge. This example shows how micro futures can be used to hedge a portfolio and reduce risk.*
When the Concept Fails
The concept of diversification fails if the assets in the portfolio are highly correlated. For example, if a trader's portfolio consists of stocks from different sectors, but all of the stocks are highly correlated with the S&P 500, the portfolio is not well-diversified. A downturn in the S&P 500 will cause all of the stocks in the portfolio to fall. It is important to choose assets that have a low correlation with each other.
Another potential pitfall is over-diversification. A trader who is invested in too many different assets may find it difficult to manage their portfolio. They may not have the time or the expertise to follow all of the different markets. It is important to find a balance between diversification and focus. A good rule of thumb is to hold between 5 and 10 different assets in a portfolio.
Finally, diversification does not guarantee that a portfolio will not lose money. It is a strategy for reducing risk, not for eliminating it. A well-diversified portfolio can still lose money in a severe market downturn. However, the losses will be smaller than the losses on a non-diversified portfolio.
Key Takeaways
- Micro futures provide access to a wide range of markets.
- This allows traders to build a diversified portfolio.
- Micro futures are a cost-effective way to diversify a portfolio.
- It is important to choose assets that have a low correlation with each other.
- Diversification is a strategy for reducing risk, not for eliminating it.
