Tips for getting started in future trading

Thinking about getting into future trading but not sure where to start? If you are a complete newbie, the nitty-gritty of futures and options may seem complex. But once you understand the basics and have futures trading strategies lined up, things should get easier.

In future trading, you deal in an instrument called a futures contract. The contract is an agreement between two parties to buy or sell an underlying physical asset on a future date at a specified price. Futures and options trading takes place on an exchange. So, you may need to open an account with a full-service broker like Kotak Securities.

How A Futures Contract Works

Say, a transport company and a fuel distributor enter into a futures contract. The transport company buys the contract, agreeing to purchase a fixed quantity of fuel from the distributor. The purchase price and date of purchase are outlined in the contract. Here, the transport company is hoping to avoid a hike in fuel prices. Meanwhile, the fuel distributor is guarding against a drop in prices and ensuring demand for its product.

Both these businesses depend on fuel—the underlying asset of the contract. But the market also has traders who want to profit from fluctuations in the contract value. These third parties will not take delivery of the asset. If the fuel price rises, for instance, the contract becomes more valuable. The owner of the contract can then book profits by selling it on the exchange.

Futures trading generally deals in commodities. But traders also buy and sell contracts on underlying stocks, bonds, exchange-traded funds, and indices.

Future Trading Contract Decoded

Before starting to trade in futures, you should become familiar with the terminology and procedures.

• Lot size: When trading in derivatives like futures and options , you cannot trade just one share at a time. So, the futures contract mentions a fixed lot of shares. The lot size depends on the exchange and may vary from one security to another.
• Duration: You can get futures contracts for one, two, or three months. When a contract reaches expiry, you can introduce a fresh contract for the same period.
• Entering a futures contract: If you enter in the cash segment, place an order with your broker, specifying the contract details (e.g. scrip, expiry date, lot size). You have to pay the ‘margin money’ upfront. This is the full value of the underlying assets. The exchange will then find you a buyer or seller.
• Settling a futures contract: Wait until expiry and the contract will be settled at the closing price of the asset on that date. Any losses or profits will now be deducted from or credited to your account. Should you wish to exit the contract before expiry, you can sell the contract or have the exchange transfer any debits or credits to you.

Futures Trading Strategies

To succeed in the derivatives market, you must have clear futures trading strategies. This means calculating the risk–reward ratios of different scrips in advance as well as outlining your entry and exit plans. A smart exit strategy is especially important. It would enable you to cut losses in time as well as book profits in a bull market without overstaying your welcome. You would also have to plan for the times when the market moves unexpectedly. Formulating such strategies will take some effort, but the eventual results will make it worthwhile.