Retail investors are normally wary of trading in futures or options are given that there is an inherent risk involved in them and there is a possibility of heavy losses in case the market turns volatile. However, even in derivatives trading, it is possible to initiate profitable trades after taking due care and planning a thoughtful strategy suitable to the prevailing market conditions. Trading in futures can act as an excellent avenue of trading in derivatives. What is a futures contract? A futures contract is an agreement to buy or sell an asset, in this case, either shares or an index at a future date at an agreed-upon price.
Remember that futures trading contracts are standardized agreements that trade on domestic stock exchanges. A Future is a right and an obligation to buy or sell an underlying stock (or other assets) at a predetermined price and deliverable at a previously agreed time. What differentiates options is the fact that options are a right without an obligation to buy or sell equity or index. A Call Option is a right to buy while a Put Option is a right to sell. So basically, options and futures are different but intrinsically similar as they try to profit from stock or an index without investing the full amount of the contract. However, while the losses are limited in option to the option premium, they are effectively unlimited in case of futures. While looking for the best online advisor for trading, ensure that you are being offered a detailed analysis of current trends in the derivatives market.
Now let`s see a few pointers that would be useful while trading in futures in Indian stock markets.
Stock or Index: Remember that you can choose to trade in either stock futures or index futures. Both these types of contracts have their own set of dynamics when it comes to price movement. While an index like Nifty50 can act on global markets, overall sentiments in the economy, political scenario and overseas fund flows, individual stock prices tend to move based upon company updates, financial earnings, sectoral developments, policy decisions, etc. In a way, an index is prone to rather a range-bound movement given that it is made up of a basket of various stocks which tends to curb the volatility. However, there are times when even indices tend to see wild fluctuations. For instance, in March 2020, following the Covid-19 onslaught, the benchmark NIFTY index saw huge daily declines of 5-7% on quite a few occasions.
Size of contracts: The basic difference between the size of contracts in futures trading is the lot size. A share has a lot size of 100 means the total value of the futures contract of such a share would be equivalent to the futures price of the share multiplied by the lot size. Hence, kindly keep in mind that you need to focus on both these aspects – price and the lot size of a future while deciding about trading it.
Margin: Margin is the collateral amount that the holder of a financial instrument like the future has to deposit with their broker. This would ensure that you can trade i.e. buy or sell a futures instrument without paying the entire amount of the contract. However, because of this, it makes a larger case to maintain discipline and trade according to your risk tolerance. Merely do not enter a trade based on what you have to pay as an upfront margin but look at the overall picture and the entire amount at stake.
Long/short: Unlike equity or share trading, in futures, you can try to profit even when an index or security falls in price. This is called going short and effectively means trying to take advantage of a decline in share prices or index values. Similarly, buying a futures contract hoping that it will rise in value is called going long. These actions have to be taken by considering the various factors affecting the market not at just a particular point in time but also in the near term. Keep in mind that there are volatile times when the index or individual stock prices can see wild movements. These will also affect the futures contract of such indices and stocks.
Liquidity: Futures contracts have a liquid and deep market in India though it makes sense to study the overall securities available for trading and choose such scrips wisely before taking any position in the futures market. While a lot of people buying and selling contracts at any given time, due to the volatile nature of the market and difference in lot sizes, it is advisable to choose only those contracts which you are comfortable with. For instance, a blue-chip company that is a part of a broad market index like NIFTY 50 may fall sharply despite no major negative news on the company front if global markets are tanking. Do not make the mistake of going long on such a company’s futures.
Remember that in a derivative like futures, your total exposure is extremely large when compared to the capital you`ve put down to open your trade in the form of margin. This makes the whole trade leveraged meaning that risk management is the key to such trading. New traders sometimes make a huge mistake by not devising a proper trading plan. A trading plan defines your goals, willingness to take risks, objectives, and an overall strategy so that even if the trade turns the other way round, you know exactly where to get out of it without inflicting massive damage. For this, just tracking the futures position is not enough. You need to clearly keep your exit strategy in place whether the trade is winning or losing. This is where stop losses come into play. Remember to cut your losses early and always let your profits run. Read More: How To Earn Regular Income Through Stock Markets