Derivatives are important because they allow investors to manage risk without having to commit all of their money upfront. Traders earn good returns because of the fluctuation in the value of the securities. However, trading in derivatives can be risky if used improperly. So, it's important to understand what derivatives are, what they do, and how they work before you start trading. In this article, we are going to learn about derivative trading, types of derivatives, how to trade in derivatives, and things to keep in mind while trading in derivatives.
What are derivatives?
A derivative is a financial instrument that derives its value from an underlying asset or security. These securities can be indices, currencies, commodities, stocks, etc. It can be used to hedge against market risk, or speculate on underlying prices.
In other words, a derivative is simply a contract between two or more parties that involves the exchange of an underlying asset or security for another financial instrument.For example, A person buys a Futures contract of a company ABC at Rs. 500 which has a lot size of 1000. Three months later, the stock is trading at Rs 550. This means, the person makes a profit of Rs. 50 per share and in total Rs. 50,000 per lot. Similarly, if the stock price falls by Rs. 50, he will lose Rs. 50 per share and in total Rs. 50,000 per lot.
Types of derivatives
The most common derivatives are options and futures:
Options: An option gives the holder the right, but not the obligation, to buy or sell an underlying asset at a set price within a certain time period.
Futures: A future is a contract that obligates two parties to exchange specified amounts of goods at a set date in the future.
How to trade in derivatives?
- Learn from a qualified trader
Before you start trading in derivatives, it's important to learn from a qualified trader. This is especially important if you're not experienced in trading in commodities, stocks, or forex markets. A qualified trader will be able to help you understand the risks involved and give you sound advice on how best to trade your options and futures contracts.
- Open Demat account
Open Demat account that suits your requirement. A good trading platform will make it easy for you to enter and exit your trades quickly and easily. You should also look for platforms that offer live updates of the markets so you can watch the trade unfold in real time.
- Use stop losses
When trading derivatives, it's important to use stop losses to protect your investment. Stop losses are set to stop the losses in case the trade doesn't go in your way.
- Maintain margin amount
When you trade in derivatives, you will be required to deposit a certain percentage of your trade, which is called initial margin.
Trading in derivatives can be a great way to make money, but it's also risky. Make sure you have obtained adequate knowledge on derivatives, how derivatives works and understand the risks involved before you start trading. Also, it is important to consider your trading objective, and risk tolerance before trading in derivatives or any other financial instruments.