In this article, you will know learn about the process to start futures trading. It is a comprehensive guide for a beginner who wants to begin trading in futures market.
Under a futures contract, a trader agrees to buy or sell an underlying asset at a defined price on a future date.
For the suppliers and producers of such assets, such as a commodity, futures contracts are an excellent medium to avoid the volatility which comes with the forces of the market.
Thus, in a futures market, traders who are ready to undertake the associated risk with the contract, agree to buy and sell futures contracts.
The motivation for any trader to enter this segment of the market and undertake a certain risk arises from financial rewards.
Trading in futures is analogous to trading for stocks in the cash segment of the market.
The only apparent difference between the two is that the investor does not take immediate delivery of the underlying asset in case of futures.
Thus, under a futures contract, a buyer and seller enter into a contractual obligation. Due to this, a trader acquires units of a stock or another asset at a future date for a pre determined price.
How to Start Futures Trading?
In the Indian context, traders have the option to choose either the National stock exchange (NSE) or Bombay Stock exchange (BSE) to trade in futures.
Here is a Step by Step Approach:
Step 1 – Prepare & understand Risk before you Start Futures Trading
Perhaps the first step to begin trading in the futures market is to understand all that there is to understand about it.
Before thoroughly understanding how futures and options operate, an investor would be undertaking a suicidal mission to put their money in the derivatives section of the market.
They are mostly different from the cash segment and mutual funds which are often easier to trade in.
Trading in futures can be challenging and risky since they are far more complex than trading in cash equity.
So, if you are entering the derivatives section of the market without complete preparation, be prepared to face the dire risks that come with it.
Step 2: Analyze your Risk Appetite
Having a risk appetite is a real concept. Everyone and anyone who trades in the market, feels driven by the motivation to make more money.
However, simply allowing this motivation to drive you in the market can be very hazardous. Every trader must have a proper idea about the amount that they might lose while trading in the market.
They must be ready to stomach the level up to which they can really afford such loss. If you end up losing big, you will be in a lot of trouble.
Step 3: Research & Assistance
Always have an approach at hand. There is no one single way to make it big in the markets. You could either base your approach on your own research or take the assistance of an expert.
Step 4: Use a Simulator before Starting Actual Trading
Any trader who wants to start off by practicing futures trading can do so with the help of a simulated account. It allows traders to practice actual trading online.
You will not be making any actual investment through this account but it will work on real market data.
This will be helpful in guiding you about the operations of the market without the fear of losing your money.
Step 5: Open a Demat Account that allows Futures Trading
Once you are prepared to apply your approach in the real world, you can open a demat account which allows trading in derivatives.
With plenty of options available out there, it is best to make an assessment of the viable options and choose the best one.
Open a Demat Account Now! – Start Trading in Futures
Requirements to Start Futures Trading
Here are few things which are required to begin futures trading.
Availability of Margin Money in Trading Account
As a futures trader, you will need to put some margin money in your account before you can start trading.
Usually, it comes around 5 – 10% of the actual size of the contract. But it is a mandatory requirement at the same time.
Without this margin money, it is unlikely that a demat service provider will allow you to trade in derivatives.
Incidentally, this is in complete contrast to the requirement of the cash markets. When a trader purchases equity in this segment, they have to pay the entire amount of the trade upfront.
But this is not something that you need in the futures market. Your broker will arrange for the transfer of these funds to the exchange.
It is possible that during the period of your contract, the amount of margin money required may go up. In such a case, you will need to pay up the extra amount to maintain your position in the market.
Start Trading in Futures
After the necessary conditions comply, you can begin trading for real in the futures market. Trading in futures is quite similar to trading in the cash segment of the market.
You will receive several options from your broker regarding the prices at which the futures contract can be entered.
You can choose the strike price, the date of expiry and the number of contracts with which you wish to trade in the market.
Settlement of Futures Contract
The last step involves the settlement of the futures contracts. You can either wait for the day of expiry or settle such contracts beforehand.
A settlement is an obligation for delivery of the futures contract as per its terms. In terms of stocks, delivery usually happens in the form of cash.
Learn everything about Futures Trading
What happens while Trading in Futures?
So, how is it exactly that you buy a futures contract? Well, the idea is to look up for an opportunity for any stock.
You may have an expectation about its price going up or falling down in the days to come. Thus, you can easily decide your approach to enter into its futures.
At first, you can scroll and browse for available futures contracts in that stock. Their prices and expiry dates are given for the trader to decide.
The broker will assess the margin requirements for the contract and check if the same is available in your account.
In the absence of the margin requirement, you will be unable to enter into the desired futures contract.
Once the margin requirement has established and enough funds are found in the account by the broker, they will search for a party to match the contract. Basically, it is a search for a second party to the contract.
Once the broker finds the second party to the contract, it is digitally signed and agreed upon by both. This gives consent to both parties to honour the contract.
The necessary margin needed for the contract is then blocked in the account of the trader. With this, the trader will own the contract for the futures trade.
Before beginning to trade in the futures, it is vital to understand your trading platform. Most rules and regulations regarding futures trading are the same at all platforms.
It is vital to ensure that the same is clear for reference in case of a future turmoil. Plus, it is absolutely necessary to understand how you can trade on the platform and the different features that it offers.
Example to illustrate Trading in Futures
Before you start trading in futures, you should definitely check this example as it will help tremendously while trading in real futures market.
This example will help you understand what it is like to trade in futures. It is worth mentioning that not having a plan before you trade is a costly error that could make you suffer losses.
If you are willing to undertake the risk and define your goals, it is vital that you design a trading strategy beforehand.
Make it as detailed as you would like. In fact, many experienced traders also design an exit strategy out of the contract. This may happen if they feel that the market is not moving as they had expected.
Let us assume that you wish to purchase a stock by the name of ABC. The lot consists of 200 stocks of ABC which have a date of expiration on 25 August. The total value of the contract for each stock is INR 200.
You will have to make payment of the necessary margin set by the exchange for this stock. Then, the broker will conclude the contract for you at the price determined by you, which is INR 200.
Now, on the date of expiry, which is 25th August, here are the three possibilities which could occur:
- The price of stock ABC could be INR 240. At this point, you can choose to exercise the contract and buy the stocks at INR 200 which will give you a profit of INR 40 on each share. This will amount to a total profit of INR 8000 on 200 shares. After reducing the amount of margin money requirements, the remaining amount will be your profit. The number of gains will be transferred to your demat account by your broker.
- The price of stock ABC could be INR 180. Since you are under an obligation to purchase the stock at INR 200, you will incur a loss of INR 20 per share, which will be a total of INR 4000 on the total value of the contract. In this case, you will have to incur this loss plus, adding the value of the margin and commissions, your total loss will be accounted for, through your demat account.
- It is possible that on the date of expiry, the price of the security remains unchanged. At INR 200, you will be at a no profit and no loss situation but the costs of margin and commissions will still remain accountable to you.
What are the Risks associated with Futures Trading?
Futures trading does not come without a fair share of risks. Among all the risks which are attributable to futures trading, the first and foremost is leveraging. It is clear that any trader who enters the futures market trades on a margin.
Thus, they leverage the value of a futures contract by 90 to 95 per cent, without ever putting up all of their money.
In this situation, it is not unlikely that a trader can sustain major losses or make huge profits as well.
What are the advantages of Futures Trading?
Even though trading in futures comes at a huge risk, there are many benefits which a trader can still accrue. Some of these are:
- Trading in futures is an opportunity to shift the risk of the trade from hedgers to speculators.
- Effective traders, who have an idea about the markets can make a definite and efficient estimate out of futures prices. They can even predict the prices of a stock or the value of an index, given the prices of the futures.
- The future demand and supply of a given stock are also possible to estimate based on futures contracts.
- Futures contracts make use of margin trading. Hence, even small traders can participate and enter into futures contracts without needing to pay the entire amount of the contract.
Some Vital Features of Futures Contract
Before starting you trade in futures market, you should also know about all the features of Futures Contract.
Although it is complex to trade in the futures contract, it can become quite easy by following a few basic rules.
As long as you are equipped with the knowledge of a few basic questions and guidelines, you will be able to trade just fine.
Some of the vital questions which you should ask yourself before trading in any futures contracts are:
- What will be the margin requirement to trade in the stock?
- What are the applicable spread and the price difference among the bid and ask quotes?
- Is there liquidity in the contract? A more liquid contract is easier to enter and exit in terms of associated costs.
- How far are the price movements consistent for the stock? If there are decent fluctuations in the volumes, then a price movement is definitely indicated.
Futures Trading for Beginners – Conclusion
Futures trading is certainly an exciting and adventurous avenue. However, it is a risky territory which must be traversed only by the experienced. As long as you are able to control your risk and trade efficiently, you should be safe.
Ultimately, what is under your control is your strategy to enter and exit a futures contract at any given point of time.
The prevailing market conditions and what they might be in the future are hardly a matter under control for any investor.
Starting trading in the futures market is not a difficult task and can be initiated with the right knowledge and experience.
Open a Demat Account Now! – Start Trading in Futures
Most Read Articles
|Discount Broker Review|
|Full Service Broker Review|
|Top Brokers in India|
|Best Intraday Trading Brokers in India|
|Best Demat Account|
|Sub Broker Franchise|
|Top 10 Sub Broker Partner in India|
|Mobile Trading Apps|