Criticisms of Paper Trading in Silver
There are some who claim that paper trading in silver, and by extension, presumably anything else that does not involve a transfer of a physical asset, results in turning financial markets into casinos of some sort.
This is not an accurate analogy, because what distinguishes casinos is the fact that they are set up with a mathematical advantage where they always come out in the end due to the way that the games are set up, providing a house edge.
This is not the case at all with the futures market though, which merely pits participants against each other in what can be rightfully be called a betting scheme, but does so in a manner that is fair to each side.
The fact that an investment bank may be taking the other side of a futures trade is not the same thing as playing against the house at a casino, and while they may have better knowledge of the market due to their much deeper resources and expertise, everyday investors can still take bets with them and the bets so to speak will be decided by the market, not by some fixed odds scheme like at a casino.
All speculation, whether it be speculating on securities or anything else, involves gambling, which means that the outcome is not known and you are placing money on one outcome over another. In the case of the silver futures market, you are betting the price of silver will go up or down depending on which side you are on, and to the degree that you are right or wrong, you will make or lose money.
Whether or not you ever intend to own silver is actually immaterial, and if people who did not have a need to do so had to go through the motions of this, this would actually be ridiculous as it would just add needless costs to the trade. You would have to buy the silver on the market, give it to someone, who has no need for silver and would just sell it back to the market, and the market’s net position would not change but both parties would pay transaction costs that were not needed nor served any useful purpose.
If you did intend to possess the silver, you could just take the cash settlement and then go out and buy it, and this limits the possession of physical silver or other assets to those who have a need for it.
There are others who have a view that the futures markets, including silver futures, should be limited to hedgers, and therefore not allow for speculation, keeping the paper traders out by some sort of decree, but we cannot ban market participation merely based upon the whims of some market participants or observers.
In order to justify prohibition of trade, we need some very good reasons, and the intention of free markets is to allow for more efficiency, permitting those who desire the opportunity to participate the ability to do so, unless a condition exists such as with inside trading that a participant would have an unfair advantage.
There is nothing unfair about wishing to speculate on the price of a commodity like silver though, and if anyone needs to be constrained in the futures markets, it is the primary participants, those who deal in actual silver or other commodities, who do often trade with inside information due to their industry knowledge, although futures markets are more liberal than stock markets in deciding what is a prohibited advantage.
The Potential Benefits of Futures Trading
What all this extra trading, the 500 to 1 leverage with paper trading, serves to do is to add much more liquidity to the silver market. More liquidity is the goal of financial markets, and this means that people can buy and sell it more easily at better prices and lower spreads than would be available without this extra liquidity.
The silver futures market isn’t particularly large compared to the more actively traded assets on the futures market, although it is large enough to make it a going concern. If we imagine what the size of it would be if it were 500 times smaller, if there were no paper trading going on, this would surely render it insignificant, and far less efficient for those who do seek to use it to deliver and purchase actual silver.
For those whose interests in the market are of a speculative nature, the silver futures market allows them to seek to profit from shorter term fluctuations in the price of silver. There is nothing that makes longer term trades more legitimate, as we are entitled to speculate on something like silver in any time frame we desire, whether that be over one’s lifetime or just for a few minutes, and everything in between.
While one may roll over silver contracts to turn these speculations into longer term trades, futures traders generally focus on shorter term outlooks, usually within the lifetime of the contract, which usually consists of a 3 month period. Traders may seek profits over a much shorter period of time as well, and all this is left to the discretion of the trader.
One can enter and exit trades very easily, by placing them electronically, and while the spreads with silver futures aren’t as favorable as you find with some commodities, they are still pretty reasonable and much more so than you would pay if you actually bought and sold physical silver.
The biggest advantage though with trading silver futures is the amount of leverage that you can use with them. You can control a silver futures contract these days for $5,775, and at $17 an ounce, this means that this controls $85,000 worth of silver
Margins in the futures market operate a little different than with the stock market, because the actual transaction is set to occur in the future, and therefore you don’t borrow the money, you instead put up a good faith deposit initially, and each day your gains or losses are added or subtracted to this amount.
You are required to maintain a certain balance with your deposit at all times, the maintenance margin, which is currently $5,280.
This allows the trader to amplify their profits and losses with silver greatly, and while the profit potential is much higher, the risk is as well. It therefore requires a higher level of skill to trade silver futures profitably, and one requires a positive expectation overall as well as the ability to handle drawdowns due to normal fluctuations in probability, but if one has both of these, trading silver futures can indeed be far more lucrative than other means of silver trading or investing.
Succeeding in Trading Silver Futures
Many budding futures traders, including those who wish to speculate on silver futures, come to the game unprepared, and also tend to not manage their risks properly, looking to hit the ball out of the park perhaps but instead ending up striking out instead, learning later that their batting skills are not yet up to par.
When both wins and losses are greatly leveraged, you do want to make sure that you have an edge before you step up to the plate in what may be considered the major leagues of silver trading, and if and when you do, to make sure that you take things slow by only trading a smaller portion of your total silver futures allocation at one time until you can be sure enough of what you are doing to place a higher percentage of it at risk.
Trade sizing is only one element though of risk management with futures trades, and one also needs to limit the size of one’s losses as well by exiting positions when they have moved against you to a degree that is either unacceptable or should be seen as such.
With the right approach though, you can certainly do very well trading silver futures, or other highly leveraged silver trading like contracts for difference, which operate similarly to futures trading. Leverage needs to be used with caution though, and it is a lack of proper caution that is the undoing of many amateur traders, and the goal initially should be to not get into more trouble than you can comfortably handle, and seek to improve from there.