Hi, In this video, we will talk about why traders are attracted to Futures markets.

Hi, In this video, we will talk about why traders are attracted to Futures markets. Traders speculate on stock prices and aim to earn profits in a short time frame of 1 to 4 weeks. This type of trading is also known as swing trading. Suppose a trader is bullish on Reliance Industries. He wants to buy 500 shares at the current market price in an anticipation to sell it higher at a later date. The trader takes up the trade in the derivatives segment by buying a futures contract of Reliance.

Now, the question is, why should one bother about buying futures? Why does one really need futures? What makes them so attractive? Why not just buy the stock and wait when there is no time factor involved? The answer to all these questions is, ‘financial leverage’. In the spot market, the trader will be required to pay the entire amount to Reliance, whereas, if he is trading in the derivative markets, a small amount of margin, say 10 – 15 % of the entire contract value, has to be paid by him. For eg: 500 shares of reliance at Rs. 1500 equals to Rs. 7,50,000 upfront in the spot market. However, in the futures market he is required to pay only 10 % which equals to barely Rs. 75000. This percentage is called the Margin, and the total value on which the margin is payable, is called the Contract Value. By virtue of margins, he can take positions much bigger than the capital available; and this is called “Leverage”. His returns on Investments increase multifold, if traded in futures compared to the Cash market.

The Key take away is that the high leverage of derivatives can result in higher profits, but that comes with the cost of higher risk, which may turn into high amount of losses, if things don’t go well. Leverage is a double-edged sword. If used in the right way and knowledge, leverage can create wealth, if not, it can destroy wealth. Calculating leverage is quite easy. Leverage = [Contract Value/Margin]. Both these terms have been explained in our discussions before in this video. Another reason why traders prefer trading in the Futures market is Short Selling. If a trader is bearish on a stock, he can short sell the same in cash only, on an intra-day basis, or he has to have holdings of the stock in his portfolio to sell the same, only to buy it at a lower price at a later date. But, through the futures market, he can easily short sell a stock without actually having holdings of the stock. He gets the time frame of approximately 1 month to keep his trade, and post that, he also has an option of a roll over in the futures market.

Traders should trade in the futures markets only after accessing their risks , keeping proper stop losses and following the same. Leverage should never be misused and over trading should be strictly avoided. Any trade taken up in the markets should be done only after proper knowledge and homework done prior to the trade. Strict discipline and an unbiased approach is always needed in futures trading.