Of all the adversity caused by the pandemic, it seems to have worked wonders for the capital markets around the world. Whereas in India, retail participation has risen for the last few years is at an unexpected growth of 45% market share in the cash segment. Moreover, in the Futures and Options (F&O) segment, retail’s share has jumped to about 30% (turnover) in Index Futures as well as Options. Sensing this opportunity, many brokerages are offering attractive margin trades and strategy plays to the investor.
However, the derivatives, once dubbed by Warren Buffet, as “weapons of mass destruction” are inherently way riskier than stocks. This rise in retail participation has got the regulator worried for some time now as it may pose both a grave financial risk to the unsophisticated investors and make the markets overly speculative as well.
Having said that here is some useful advice if you are thinking to give the F&O a shot lately.
Derivatives to hedge risks
The derivatives were invented to hedge risks of loss on an existing exposure and not to make profits. Speculation as well is not everyone’s cup of tea.
Derivatives are strictly recommended for those who have built sufficient financial shields to withstand severe losses in trading capital which is possible in the F & O segment.
F&O requires forecasts of price levels over a horizon of three months maximum which requires a great deal of skill and ability by studying and observing technical charts and derivative analytics. One should consider educating oneself about the technical analysis or avoid it completely.
Derivatives are tempting because of leverage as it allows you to take exposure to a larger value by committing only a fraction of it. If it turns out profitable it might give you gains in the manifold but compounds your losses too with equal ferocity if they don’t.
Writing options are only for pros. upfront cash inflow and the theoretically superior chances of winning can blind you to the risks but they can wipe out your entire capital.
Keep losses small
The timeless wisdom of the professional trader is: It is not the towering gains that ensure trading success in the long run; it is your ability to keep losses small instead. One should have a reasonable risk-reward ratio and should stick to it no matter what is the real trick.
F&O is not investing but trading. Most amateur traders fail and get out of the market very soon. Also, it is a full-time profession, requiring considerable skill and patience. As the trading gets more technical, it is becoming tougher except for sophisticated players. The retail trader hardly has the agility and strength to discover the numerous opportunities flashing for a nanosecond on charts.
The author believes that retail investors will flourish better if they stick to goal-based investing in long-term avenues like mutual funds. It may not be as exciting as F&O trading, but it surely is durable and healthier.
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