Futures trading lets you tap into diverse market opportunities.
Futures Trading
The stock markets offer multiple opportunities and tools to invest and grow wealth. Some of these tools include stocks, bonds, mutual funds, and derivatives. Futures contracts are one of the derivative instruments that investors are increasingly using to boost their profits.
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According to NSE data, derivatives' turnover grew 23-fold over the last 5 years to reach ₹79,927 trillion at the end of March 2024. While RBI (Reserve Bank of India) and SEBI (Securities and Exchange Board of India) are closely monitoring the substantial rise in volumes, the data highlights rising investor interest in futures trading.
So, what is futures trading, and how can you use it to tap into market opportunities and manage risk? Let’s find out.
What Is Futures Trading?
Futures trading involves entering into derivative contracts that commit you to buy or sell an asset at a predetermined price on a specified future date.
Just like stocks, futures contracts are also traded on stock exchanges. These are called derivatives because they derive their value from the underlying asset, which can be a stock, a bond, a currency, etc. The contracts are standardised agreements that specify the amount and quality of the underlying asset, making them easy to trade on exchanges.
Here's how it works: Suppose you estimate that the price of Reliance Industries' stock will rise in the next three months. So, you enter into a futures contract to buy Reliance shares at today's price. Now, if the stock price of Reliance rises as per your expectation, you can sell the futures contract at the higher market price before the contract expires. This allows you to make a profit. Conversely, if the price drops, you may incur a loss.
Exploring Market Opportunities With Futures Trading
Futures trading lets you tap into diverse market opportunities. Let’s see how.
Suppose you expect the stock price of Reliance Industries to rise in the coming months. Instead of buying the shares directly, you can enter into a futures contract for Reliance Industries. This means you agree to buy the stock at today's price, even if the price goes up in the future. If the stock price increases as you predicted, you can sell the contract at a higher price and earn a profit.
Similarly, if you expect the stock price of Tata Motors to decline due to some upcoming challenges in the automobile sector, you can sell Tata Motors futures. By doing this, you agree to sell the stock at today's price, even if the price goes down in the future. If the stock price drops, you can execute the contract at the agreed price and profit from the difference.
With futures trading, you can make the most of both rising and falling prices. This means you can potentially profit no matter which direction the price moves as long as you use Futures trading strategically.
Essential Strategies For Futures Trading
Futures trading can be complex, but you can begin by using some of these basic strategies while you continue to understand the market. Let’s understand how each works.
Hedging - It is like buying insurance for your investments or protecting your investments. Imagine you own several stocks, and you're worried that their prices might fall. To protect yourself, you can sell futures contracts related to those stocks. If the market drops, the losses in your stock portfolio can be balanced out by gains in the futures contracts you sold. This way, you minimise the overall impact on your investments.
Spread trading - This involves taking advantage of the price differences between two related futures contracts. Here, spread refers to the difference in prices. Think of it as buying something at a low price in one place and selling it at a higher price in another place. In futures trading, you might buy a contract that expires in one month and sell a similar contract that expires in a different month. The idea is to profit from the price difference between the two contracts over time.
Arbitrage - This strategy lets you exploit price differences in different markets such that you can earn risk-free profit. For instance, if a futures contract is cheaper on one stock exchange and more expensive on another, you can buy the cheaper contract and sell the more expensive one at the same time. This way, you can make profits from the difference in prices and without any risk.
Before diving into futures trading, it's crucial to educate yourself about the basics. Remember, successful futures trading demands continuous learning and a well-informed approach. Start trading with a small amount to gain practical experience without taking on significant risk.
Allow yourself time to learn and refine your strategies over time. With the right knowledge and tools, you can navigate the futures market with confidence.
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