Future contracts are not a new type of financial instrument; in fact, the concept has its roots in ancient civilisation. The modern future market started taking shape in the 19th century. Since then, this instrument has evolved tremendously, and now it is used not only for hedging but also to earn long-term profits.
In the below article, we shall discuss how future trading can help you attain long-term profits and much more.
Understanding Future Trading
As we are aware, a future contract is an agreement between the buyer and seller to transact an asset at a predetermined price at a predetermined date. Future contracts in India are traded through NSE or BSE and offer counter-guarantee of the clearing corporation.
Traders use future trading strategies to determine when to buy or sell contracts. Typically, traders use a combination of both technical and fundamental analysis to create strategies that help them reduce risk and increase their profit margin.
The Importance of Long-Term Thinking
When we think of derivative instruments like futures, we assume it is only for short-term trading or to hedge your risk of arbitrage in the spot market. However, futures can also be held for a longer term and can be an excellent substitute for your stock investments.
Margins and leverage
Unlike holding equity shares in the spot market, futures need not be paid in full. Only a certain percentage of the contract amount is charged to buy or sell futures, known as margin.
So, if the future margin for a particular stock is fixed at 20%, you can buy or sell 5 times more shares in the future market than in the equity market. Thus, with a 20% margin, you get a leverage of 5. Further, this would mean that you can earn 5 times the profit than the equity market, but the losses, too, could be very high.
Future trading for long-term
Hence, by applying this concept, if instead of buying stocks in the spot market, you decide to buy them in the futures market, you will pay just the margin, and the balance of money is free to be used elsewhere. This balance money can be invested in a mix of liquid and debt funds for protection. Hence, future contracts can also be considered for long-term investments.
Diversification and Portfolio Building
Indeed, future trading requires immense time, energy and knowledge. You must be well-versed with the latest developments and invest time and effort in understanding the charts and other resources, and trading in multiple markets may not always be possible. However, sticking to just one market is not a smart approach either.
Just like diversification is important in trading or investing in the spot market, it plays a vital role even in the futures market. For example, if you anticipate that the prices of crude oil will rally and that of cocoa will fall, even if one of your expectations is proved wrong, you can offset the loss with the other.
As a trader, it is imperative to stay informed about market developments as this information is vital to adapt strategies, identify opportunities, and manage risks. Updating oneself on market trends, economic indicators, and asset-related information can help you understand the impact of price fluctuations, thereby guiding you in making better-informed decisions.
Trading in futures can be an exciting and profitable option if you undertake effective strategies and adequate risk management approaches. The best way to begin your journey in future trading is to sign up for a good trading account in India that not only offers a host of features but also excellent resource materials at affordable prices.