A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

by Burton G. Malkiel

Suppose, for example, you believed that the prices of stocks of smaller companies would rise relative to stocks of larger companies. You might buy a three-month future on the Russell 2000 index (an index of smaller firms) and sell an equivalent futures contract on the S&P 500 (an index of the biggest companies). Note that you would be hedged in the sense that if all stocks went down, you would lose on your Russell 2000 contract but gain on the S&P contract. As long as small stocks did better than large stocks on a relative basis, you could gain whatever the direction of the general market. However, if the relative performance figures went the other way—that is, big-company stocks did better than small-company stocks—you could lose substantial sums of money. This is so because futures markets allow you to control billions of dollars worth of securities while putting up a security deposit of only millions. Derivatives truly provide investors with staggering amounts of leverage.