Futures Trading Tips for Beginners

What are futures?

Futures is a common terminology in derivatives trading. Essentially, futures is a derivative contract through which you can buy or sell an asset at a predetermined price on a future date. Using futures can help you lock in prices and manage risks related to price fluctuations. A futures trading example will help you better understand it.

Imagine a wheat farmer in Punjab worrying about the possibility of prices dropping at the time of harvest in November. The farmer enters into a futures contract in July, agreeing to sell 100 quintals of wheat at ₹2,000 per quintal, regardless of the prevailing price at that time. Through a futures contract, the farmer ensures that he will get ₹2 lakh for 100 quintals of wheat sold.

What is traded in the futures market?

The futures market involves trading various financial instruments, including commodities like oil, rice, and wheat, as well as stocks, exchange-traded funds, and currencies.

Futures trading strategies for beginners

If you are a beginner and wondering how to trade futures, here are some strategies you can deploy to get started:

• Understand the basics

Before getting started, understand the basics of the futures. Get acquainted with the associated terminologies and read extensively about their working mechanics. You can find several resources on the web in the form of blogs, articles, and videos that will help you easily grasp key concepts. You can trade confidently once you have a solid understanding of the concepts.

• Practise mock trading

Practising mock trading can help you better understand the nitty-gritty of futures trading. Today, many paper-trading apps allow you to practise virtual trading without using real money. These apps enable you to test the waters before investing and hone your skills.

With interactive charts, real-time data, technical analysis tools, educational resources, and more, you can have a granular view of how futures trading works in real life. You can test your strategies before committing.

• Focus on one market

While you can conduct futures trading in different assets, as a beginner, it is prudent to focus only on one market. Focusing on one market allows you to understand market dynamics better, be it commodities or financial instruments.

Note that every market and financial instrument is different. Focusing on one market makes it relatively easy to concentrate and enhances one's chances of success.

• Have proper risk management strategies in place

Risk management is a vital aspect of trading. Futures trading can be quite risky, and you can incur substantial losses if prices move against your expectations. Using a stop-loss order is one way to mitigate risk with futures trading. A stop-loss order automatically squares off your position when prices reach a certain level, thus limiting your losses. Let us understand how you can use a stop-loss order.

Suppose you buy 10 shares of a particular company, with each share priced at ₹2,500, thus investing a total of ₹25,000 (₹2500 X 10). You set a stop-loss order at ₹2,400 per share. It means the shares will be sold immediately as soon as the price drops ₹2,400.

When prices hit ₹2,400 per share, all your 10 shares are sold at ₹24,000 (₹2,400 X 10). Thus, your losses are limited to ₹1,000 (₹25,000 - ₹24,000). Your losses could have been even more if you had not placed a stop-loss order.

• Stay Informed

Several factors influence futures trading, including geopolitical events, company news, micro and macroeconomic factors, etc. Staying informed can help you better understand markets and thus make informed trading decisions. Browse financial news portals, national and international, to stay updated.

• Start Small

Start small and do not commit a large sum of money to futures trading immediately. Once you have a solid understanding of the futures trading market dynamics, you can gradually increase the amount according to your goal and risk tolerance.

Overview of how futures are different from options

Along with futures, options are another common term you are likely to hear in derivatives trading. The table captures the essential differences between futures and options on various parameters:

Conclusion

If done with prudence, futures trading can help you protect against losses due to price volatility. That said, it is crucial to be aware of the risks involved and adopt due diligence before proceeding. Seek professional help whenever in doubt.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.