Futures are a financial contract that obligates the buyer to purchase, or the seller to sell, an asset at a predetermined future date and price. These contracts are standardized to facilitate trading on a futures exchange. They are typically used to hedge or speculate on the price movement of an underlying asset, which can include commodities, currencies, indices, or other financial instruments.
Characteristics of Futures
Standardization: Futures contracts are standardized in terms of quantity, quality, and delivery time, which makes them different from forward contracts that are customizable.
Leverage: Futures contracts allow traders to control a large amount of an underlying asset with a relatively small investment, known as margin.
Expiration Dates: Unlike stocks, which can be held indefinitely, futures contracts have specific expiration dates when the contract must be settled.
Mark-to-Market: Futures are settled daily, with profits and losses being credited or debited to the trader’s account each trading day.
Delivery and Settlement: Futures can be settled in two ways: physical delivery of the underlying asset or cash settlement, depending on the terms of the contract.
Difference from Other Financial Instruments
Futures differ significantly from other financial instruments like stocks and options:
No Inherent Value: Futures contracts themselves do not have intrinsic value. Their value is derived from the underlying asset, whereas stocks represent ownership in a company with potential for dividends and capital gains.
Expiration: Futures contracts expire on a specific date, after which they are settled. Stocks, on the other hand, can be held as long as desired.
Leverage and Margin: Futures trading involves using margin, allowing for greater exposure with a smaller investment. This can magnify both gains and losses, unlike stocks where the investor must pay the full price unless using margin trading.
Daily Settlement: Futures are marked to market daily, meaning gains and losses are realized at the end of each trading day, while stocks are not.
Risk and Return: Futures can offer higher potential returns due to leverage but also come with higher risk. Stock investments typically involve less leverage and thus might be seen as less risky.
See also: What Is Dax Futures?
Risk Assessment
Determine Your Risk Tolerance
Before diving into futures trading, it’s crucial to assess your risk tolerance. This involves understanding both your financial capacity and emotional comfort with potential losses.
Financial Capacity: Evaluate how much capital you can afford to lose without impacting your lifestyle. This includes considering your income, savings, and other financial commitments.
Emotional Comfort: Trading futures can be highly stressful due to the leverage involved and the rapid market movements. Ensure that you are comfortable with the possibility of significant losses and can manage stress effectively.
Diversification: Avoid putting all your capital into futures trading. Diversifying your investments can help manage risk and reduce the impact of potential losses in futures trading.
Knowledge and Experience: Your familiarity with futures markets and trading strategies will significantly influence your risk tolerance. Consider starting with smaller positions as you build experience and confidence.
Potential Risks in Futures Trading
Market Risk: The primary risk in futures trading is market risk, which is the potential for losses due to adverse price movements in the underlying asset.
Leverage Risk: The use of leverage can amplify both gains and losses. A small adverse price movement can result in substantial losses.
Liquidity Risk: Some futures contracts may have low liquidity, making it difficult to enter or exit positions without significantly affecting the price.
Margin Calls: If the market moves against your position, you may be required to deposit additional funds to maintain your position (margin call). Failure to meet margin calls can result in forced liquidation of your position at a loss.
Counterparty Risk: Although futures exchanges mitigate counterparty risk through clearinghouses, there is still a residual risk that the other party may default.
See also: What Are Djia Futures?
Trading Strategy
Decide on a Trading Strategy
Successful futures trading requires a well-thought-out strategy. Here are some common strategies to consider:
Trend Following: This strategy involves identifying and trading in the direction of market trends. Traders use technical analysis tools such as moving averages, trend lines, and momentum indicators to determine the trend and establish positions accordingly.
Mean Reversion: This strategy is based on the idea that prices will revert to their historical mean over time. Traders identify overbought or oversold conditions and place trades expecting a reversal towards the mean.
Spread Trading: Spread trading involves taking simultaneous long and short positions in related futures contracts to profit from the price difference between them. This can be an intra-market spread (different contracts within the same market) or an inter-market spread (contracts from different markets).
News-Based Trading: This strategy involves trading based on market reactions to news events, such as economic reports, geopolitical developments, or corporate announcements. Quick reactions and staying informed are crucial for this approach.
Algorithmic Trading: Advanced traders may use algorithmic trading strategies, where computer programs execute trades based on predefined criteria. This can involve high-frequency trading, statistical arbitrage, or other complex models.
Practice with a Demo Trading Account
Before committing real money to futures trading, it is highly advisable to practice using a demo trading account. Many brokers, including Angel Broking, offer demo accounts that simulate real trading conditions.
Understanding Market Dynamics: A demo account allows you to get familiar with market dynamics, including order types, market depth, and volatility, without risking real money.
Strategy Testing: Use the demo account to test and refine your trading strategies. This helps identify strengths and weaknesses in your approach before implementing it in the live market.
Risk Management: Practice managing risk by setting stop-loss orders, determining position sizes, and adhering to your risk tolerance limits.
Gaining Confidence: Trading in a simulated environment builds confidence and helps reduce the psychological pressure when transitioning to a live trading account.
Open a Trading Account
Steps to Open a Trading Account with Angel Broking
To start trading futures, you need to open a trading account with a reputable broker like Angel Broking. Here are the steps involved:
Choose the Right Broker: Research and select a broker that offers futures trading, competitive fees, robust trading platforms, and excellent customer support. Angel Broking is a well-known broker in India that meets these criteria.
Complete the Application: Fill out the online application form on the broker’s website. You will need to provide personal information, financial details, and proof of identity and address.
KYC (Know Your Customer): Complete the KYC process by submitting the required documents. This typically includes a government-issued ID, address proof, and possibly financial statements.
Agreement Signing: Read and sign the brokerage agreement, which outlines the terms and conditions of trading with the broker.
Account Approval: Once your application and documents are reviewed and approved, your trading account will be activated. This process can take a few days.
Fund Your Account: Deposit funds into your trading account to start trading. Ensure you meet the minimum deposit requirements set by the broker.
Importance of Background Checks on Trading Accounts
Conducting background checks on trading accounts and brokers is crucial to ensure the safety of your investments. Here are some factors to consider:
Regulatory Compliance: Verify that the broker is registered with and regulated by relevant financial authorities. In India, brokers should be registered with the Securities and Exchange Board of India (SEBI).
Reputation and Reviews: Research the broker’s reputation by reading reviews and testimonials from other traders. Look for any history of fraud or regulatory issues.
Financial Stability: Ensure the broker is financially stable and has a strong track record. This reduces the risk of the broker defaulting.
Trading Platform: Evaluate the broker’s trading platform for reliability, user-friendliness, and the availability of necessary tools and features.
Customer Support: Good customer support is essential for resolving any issues that may arise during trading. Test the broker’s support services to ensure they are responsive and helpful.
Margin Payment
Understanding Margin in Futures Trading
Margin is the amount of money that must be deposited with the broker to open and maintain a futures position. It acts as a security deposit to cover potential losses.
Initial Margin: This is the minimum amount required to open a position. It is typically a percentage of the total contract value.
Maintenance Margin: Once a position is opened, a minimum balance must be maintained in the account. If the account balance falls below this level due to losses, a margin call will be issued.
Margin Call: When a margin call occurs, the trader must deposit additional funds to bring the account balance back to the required level. Failure to do so may result in the position being liquidated.
Variation Margin: This is the daily profit or loss adjustment to the margin account based on the market movements of the futures contract.
Margin Requirements for Different Types of Traders
Retail Traders: Individual traders who trade futures for personal
investment. They typically face higher margin requirements compared to professional traders.
Professional Traders: These traders, including institutional investors and hedge funds, often have lower margin requirements due to larger capital and better risk management practices.
Day Traders: Traders who open and close positions within the same trading day may benefit from lower margin requirements. However, they must meet specific criteria set by the broker.
Margin Payment Process
Calculate Margin Requirement: Determine the initial margin requirement based on the value of the futures contract and the margin percentage set by the broker.
Deposit Funds: Transfer the required margin amount to your trading account. This can be done via bank transfer, credit/debit card, or other payment methods supported by the broker.
Maintain Margin Balance: Monitor your account balance regularly to ensure it remains above the maintenance margin level. Be prepared to deposit additional funds if needed.
Margin Call Management: If a margin call occurs, act promptly to deposit additional funds to avoid forced liquidation of your positions.
Angel Broking Margin Policies
Angel Broking, like other brokers, has specific margin policies that traders must adhere to:
Initial Margin: The broker sets the initial margin requirement for each futures contract, which must be deposited before opening a position.
Maintenance Margin: The maintenance margin level must be maintained to keep the position open. Falling below this level will trigger a margin call.
Leverage Ratios: Angel Broking offers different leverage ratios for various futures contracts. Higher leverage allows for greater exposure but also increases risk.
Automated Margin Calls: Angel Broking has an automated system that monitors margin levels and issues margin calls when necessary. Traders are notified promptly to take action.
Risk Management Tools: The broker provides tools and resources to help traders manage margin requirements and mitigate risks effectively.
Conclusion
Trading futures with Angel Broking can be a lucrative endeavor, but it requires a solid understanding of the basics, a clear assessment of your risk tolerance, a well-defined trading strategy, and diligent margin management. By following the steps outlined in this article, you can navigate the complexities of futures trading and make informed decisions that align with your financial goals.
Related topics:
