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Futures trading in stock index gives leverage. Leverage cuts both ways. It can give you huge pct gains or wipe you out.

Typically stock index futures for the major markets have limited daily pct change to upside but to downside there could be huge pct changes. 20 pct sp500 lost in 87 crash. Around 11pct highest daily gain.

We see negative skew. So there is bigger downside risk.

If one has enough capital to make margin calls can they ride out a huge daily decline ? Just hold on long enough and market will eventually recover. It may take 15 years like for Nasdaq but eventually will.

So the loss is eventually made up and you do not go bankrupt.

Note that upside risk is different story as there is no guarantee market will return to lower level.

What is wrong with this logic ?

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  • $\begingroup$ Hi drhu, welcome to Quant.SE! What exactly is your argument, that investing is a good idea no matter what because eventually stock markets will go up? That doesn't seem true to me, it only seems that way in the US. $\endgroup$
    – Bob Jansen
    Oct 18, 2015 at 19:09
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    $\begingroup$ If you set capital aside to cover your possible losses, there is no need to go leveraged in the first place, as your return on (futures + cash set aside), intuitively, should be more or less equivalent to return on the underlying stock. $\endgroup$ Oct 18, 2015 at 22:39

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I think that the key is with youe last comment: Note that upside risk is different story as there is no guarantee market will return to lower level.

You don't know if it will recover when you have a bull or bear market. In the other hand, let's say that it takes 15 years to recover to the actual value. Is it worth the same $100 15 years ago, and nowadays? As you know it isn't, so you have lost money. In addition, there is the value of opportunity and so on....

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A market does not always come back. According to Brown, Goetzmann and Ross, half the stock exchanges in existence in year 1900 had significant interruptions or were completely abolished.

Beware of survivorship bias!

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Basically, based on your assumptions, your logic is correct. However, it's a kind of waste for your money. During the bear market, you still have opportunities to gain at least risk-free return. But if you just put that money in the margin account, you cannot get that profit. This is what we call "opportunity cost". So in bear market, it's perhaps a better choice to end the long position and invest your money on other assets or simply take a short position.

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Your logic is incorrect because it doesn't make best use of the capital. What if the stock never come back up? Even it does, do you really want to tie your funds in something that you don't know when you can get back?

Mathematically, your problem can be modelled by a discount factor. Your money in 15 years will be eaten by the discount factor badly.

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