The derivative market in India is gradually achieving significance. Ever since it was announced in the year 2000, its reputation has grown a manifold.
Briefly summing it up, a derivative is a financial instrument whose value is derived from another asset, liability or an external factor. This other market, known as the underlying market, includes individual stocks, stock indexes, and currency markets.
There are numerous derivatives instruments, each comprising of various distinct derivatives that can be traded.
The financial instruments like stocks, bonds, commodities and currencies are all denoted to as cash instruments, meaning that the value of these is decided directly by markets.
To the contrary, as described earlier, a derivative obtains its value from the value of some other financial resource. For example, an interest swap is a derivative because it derives its value from an interest rate index.
The most commonly traded derivatives are forwards, futures, options, and swaps.
Depending on a trader and the capital necessities, one instrument may be more suitable than the other. While any one derivative market is not essentially better than the other, each market requires different capital amounts to trade, based on the margin requirement of that market.
Although Futures market is more popular with the day traders, Options and CFDs are popular among the swing traders, who take trades that can last from a couple of days to weeks.
Similar to the cash fragment of the stock exchange market, derivatives market trading involves certain crucial points, which can provide you with choices. Remembering the following tips before trading in the derivative market will prove to be beneficial.
This is one of the most imperative steps for the derivatives market. However, it would do you good to remember that the approaches need to change from that of the stock market. For instance, you buy stocks that are likely to raise in the future, which means that you conduct a buy transaction. Conversely, in the derivative market, this would need you to enter into a sale transaction, thus the strategy would differ.
Arrange for required Margin Amount
Similar to stock market trading, derivative market rules require you to maintain a certain amount as a margin in your trading account. This means that at any point in time until the trade is settled, you cannot withdraw this amount. Moreover, remember that the margin amount changes as the price of the underlying market changes.
Get a trading account
Conduct all the trading transactions through your trading account. Firstly, ensure that your account allows you to trade in derivatives and if not, then get the required services activated, after which you can place an order online or through a broker.
Ensure that it fits your budget
Select your stocks and their contracts based on the amount you have in hand, the price of the underlying shares, the margin requirements, and the price of the contracts. All of this combined should fit your budget.
Appropriate Exit strategy
Wait until the contract is scheduled to expire to settle the trade. Now, you can pay the whole amount outstanding or you can enter into an opposing trade. This will determine whether you book profits or losses.
The best part about derivatives is that greater the risk, the higher is the reward. Therefore, if you want to access market opportunities do not leave out the derivatives financial instruments.
In this market, risk management is your friend; henceforth choose an angle that will yield the maximum rewards and minimum loses. Although the risk associated with trading can be daunting at first, it can turn out to be potentially fruitful. The choice lies in your hands!
Skint Dad contributors offering a different and unique voice to help you save, learn and earn.