How to Start Futures Trading?

If you want to trade futures, you start with opening your trading account with a SEBI registered broker like India Infoline Securities. That is the first step. You cannot participate in the F&O market and trade futures unless you have an activated trading account. A Demat account is not mandatory if you only want to trade futures but since futures are deemed for delivery, most brokers will insist that you open your Demat account simultaneously and that is a good idea.

Once you are done with the account opening formalities like signing the trading agreement, completing your KYC, activating your trading account, etc, you are all set to trade futures. Ensure that you also activate online trading so that you are in control of your orders from end to end. It is quite simple and with a few hours spent on the job, you are ready to do so. However, having activated your trading, the question remains as to how to start futures trading? It may not be rocket science, but there are some basic tricks of the trade you must know. Here let us focus on how to start trading futures. What are the first steps to be aware of before you trade futures?

Understand to Start Futures Trading?

Futures are slightly more complicated than cash markets because they are not assets but they are contracts. Secondly, futures are leveraged products. For example, when you trade futures and pay a margin of 20%, you are taking 5 times leverage. That means; just as your profits can multiply 5 times; your losses can also multiply 5 times. Now, that is not a very comforting thought, right? Let us understand some points to remember which will help us on how to start trading futures on the Nifty and on specific stocks.

A simple first step is to check the futures premium

What does this exactly mean? When you trade futures, you will realize that futures normally trade at a spread over the spot price, called the premium. Under normal conditions, the monthly spread over the spot price is decided by the prevailing interest rate. For example, if the interest cost is around 0.9% per month, then the spread will equal a monthly return of around 0.9%, although it could be volatile. Since futures have a cost of carrying the futures normally quote at a premium. As a trader starting, here is what you must remember. Don’t buy Nifty futures or stock futures when it is at a steep premium to the spot value. The spit could be at a discount due to selling in the cash market. Secondly, don’t jump in and buy futures when they are at a discount to the spot price. That could be due to futures selling or due to dividends or corporate actions.

As we said, leveraged positions can magnify both ways

Nifty futures and stock futures are leveraged positions and that is something you must never forget when you trade futures. If you pay a 10% margin on a Nifty lot, you are getting 10 times leverage. That sounds exciting because profits could be 10-fold but then losses can also get magnified. When you trade futures, don’t forget the downside risk of the leveraged positions. That is why to avoid the cascading effect of the leverage, you must ensure that you trade with strict losses and profit targets, especially when you trade futures.

Yes, there is a lot of data research to be done in future too

When you trade futures, it is not like a blind gamble on the stock using leverage. That can be dangerous. Instead, there is a lot of exclusive futures data that is at your disposal to help you take a smart view. With that data, you can do some serious scientific data analysis before you trade futures. For example, a quick look at the open interest of the Nifty futures and its accumulation trends will tell you whether the open interest build-up is on the long side or the short side of the trade. Also, when you compare the futures OI accumulation and compare with price movement, you get a quick view of whether this is buying, selling, long unwinding or it is Short Covering All these are useful tips when you trade futures.

Like in the cash market, you need easy entry and exit from futures too

You may not worry much about this liquidity risk when you trade futures on Nifty, Bank Nifty, or front-line stocks. But this is a very big risk when you trade in mid-cap stock futures. Firstly, on the expiry day, you will normally find the volumes on the Nifty futures vanishing and now with the mandatory delivery on stock futures in the last week, this can be an issue quite often. Also, when the market is falling sharply, spreads can widen substantially increasing your risk in trading Nifty futures. There have been occasions when the spreads on RIL have gone up to 4-5 rupees in peak disruption time. That is a risk to watch out for when you trade futures.

Be prepared for the margins liability at multiple levels

When you trade futures, you have to live with the margins at various levels. There are initial margins to be paid when you enter into futures contracts. This applies to long futures and short futures i.e., irrespective of whether you buy futures or you sell futures. When you trade futures, the initial margin is paid at the time of taking the position which includes the VAR margin and the ELM margins. Currently, brokers must collect both these margins and ELM is no longer optional, as it was in the past. More importantly, you must be prepared daily to pay up the MTM (mark to market) margins based on the price movement. So, when you allocate X amount of capital to a trade, make provisions to the initial margins, MTM margins, and any additional volatility margins that may get imposed along the way. These are factors beyond your control when you trade futures.

For starters avoid overnight risk and weekend risk

In the futures market, a lot can happen in a day and a lot can happen over the weekend. After all, never forget that when you trade futures, you are leveraged. Your stop losses are only for during the day and it will not cover your overnight risk. What happens if the Dow falls by 800 points and the Nifty opens on SGX with a gap down of 250 points. You are already going to be worried about MTM margins or you must force close your futures position. To begin with, keep it strictly intraday.

Play the devil’s advocate for every trade

What does this mean? Let us put it this way. When you buy futures on Nifty, there is an X counterparty that is selling these futures. Try to understand why the other party is selling futures. If it is just a hedge, it is OK. But if the other party is selling futures short, you are probably missing something out. This is a very interesting and objective analysis. The other party could be a trader or a hedger and the open interest data can give you the required indications and the necessary insights. While you are bound to be driven by your view on the Nifty, it always pays to understand the perspective of the other party to the trade. You may have missed out on something which becomes evident now.

Track dividends and transactions costs on futures positions

When you trade futures, remember that futures don’t earn dividends, only cash positions earn dividends. Hence dividends lead to futures quoting at a discount to reflect this notional loss of holding futures versus cash. Secondly, when you trade Nifty futures, there are brokerage and statutory costs and they make a big difference to your break-even point and your profits on the trade.

What are the advantages of futures?

There are five distinct advantages when you trade futures and here is what you must know.

1. You can hedge risk. If you own a portfolio of stocks and expect the stock prices to come down, you can take a counter position in the future and limit your loss. This is hedging.
2. Speculating should never be the core idea of futures trading but it is an advantage nevertheless. You can buy or sell in futures and you do it with the benefit of leverage.
3. In a restricted market like India, trading futures gives you a short selling opportunity. You cannot sell in cash unless you have delivery. Cash selling can at best be for intraday trading. Instead, you can take short positions using futures.
4. Now, this is a double-edged sword called leverage. You pay a margin and trade many times so you reduce your investment in a position. But it can backfire too, so be careful.
5. You can take a macro view on indices, macro development in the market, sectoral stories, thematic stories, etc without getting into stock-specific risk.

What are index futures?

Index futures are futures contracts on an index. This can be a broad-based index like the Nifty or Sensex. Alternatively, it can also be index futures on sectoral indices like the Bank Nifty, Financial Services Nifty or Nifty IT, etc.