Introduction
You already know that a lot of money can be made in the stock market. Through our previous videos based on the stock market, you must have also begun to understand that in this market, both earning and losing money is possible. Yes, but with the right strategy and patience, profit can be gained. Without knowledge, the desire to earn more can lead to losing everything. So, regarding this stock market, you must have also learned that profit is not only made by buying and selling shares. There are many other ways to earn and grow money, such as options trading. If you haven’t seen the video based on this, do watch it. It will be very beneficial for you.
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Understanding Futures Trading
Today, we will discuss a trading method that, like options trading, is very special. It’s a bit complex and helps in earning, as it is called futures trading. Futures trading is a type of derivative trading, similar to options trading. In derivative trading, you bet on the actual price of an asset without buying anything. This is called an underlying asset, and it can be things like stocks or currencies. If your prediction is correct, you earn a profit; if it’s wrong, you can lose money.
Buying shares means buying a piece of the company, whereas in derivatives, you place a bet on the price of that share without buying it. Derivative trading is mainly of two types: options trading and futures trading. Today, we will learn in detail about futures trading, including what it is, how it differs from options trading, the difference between stock trading and futures trading, which investors this trading is suitable for, what benefits it has, and what risks are involved.
What is Futures Trading?
Futures are a type of financial contract in which bets are placed on the future price of an underlying asset like stocks, gold, and oil, without buying it. In this, you decide that at a fixed date in the future, you will buy or sell that asset at a fixed price. The price at which you agree to buy or sell that asset is called the strike price. For this promise, you also have to give a small amount to the broker, known as margin. This acts as a security deposit.
Futures contracts also have an expiration date, on which the contract ends, and on that day, you must buy or sell the asset. For example, if you think that the price of gold will rise next month, you buy a futures contract. This means you agree to buy gold at a fixed price next month. Here, gold is the underlying asset.
Difference Between Futures Trading and Options Trading
In options trading, you are not obligated to use the underlying asset, meaning it’s not necessary to buy or sell that asset. In futures trading, however, you must buy or sell that asset at a fixed time and price. You cannot refuse it. This is why options trading is considered comparatively less risky and more flexible than futures trading.
If we look at the difference between stock trading and futures trading, both are related to the stock market, but there are significant differences. In stock trading, you buy shares of a company and thus purchase ownership. In futures trading, you buy a contract where you only place a bet on the future price of an asset.
Stock trading is less risky and is preferred for long-term investments, while futures contracts expire after a set date, involving much higher risk. If you buy shares of a company, you are engaging in stock trading, but if you buy a contract agreeing to buy that company’s shares at a fixed time and price in the future, it is futures trading.
Types of Futures Trading
Futures trading occurs on stock exchanges, and in India, there are two major stock exchanges: the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Through these exchanges, different types of futures contracts, such as index futures and commodity futures, are traded. In India, anyone over 18 years old with a demat and trading account can engage in futures trading. However, due to its risky nature, futures trading is generally suitable for those traders who prefer short-term trading with high risks.
Additionally, those who have a good understanding of the market and have available margin amounts for this trading. After knowing all this about futures trading, let’s now understand its types. There are two main types: index futures and commodity futures.
Index Futures
Index futures involve placing bets on the future prices of stock market indices. An index is a group of selected company shares that represent the stock market. It is used to measure the performance of the market. An index indicates whether most companies in the market are performing well or poorly. If the index is rising, it means that most companies are performing well.
If the index is falling, the companies’ performance is not good. You must have heard of Nifty 50 and Sensex. These are both indices. The Nifty 50 includes shares of India’s top 50 companies, and the Sensex includes shares of 30 large companies listed on the BSE. When the prices of these companies’ shares rise, the index value also increases, and when their prices fall, the index price decreases.
Now, after understanding the index, let’s talk about index futures. These are contracts in which predictions are made about the future prices of stock market indices like Nifty 50 or Sensex. It works like this: you predict whether the index price or value will increase or decrease. Based on that, you buy or sell a certain number of index futures contracts.
The contract has a fixed expiration date. If your prediction is correct on the expiration date, you earn a profit; otherwise, you incur a loss. For example, let’s say you think the Nifty 50 index will rise next month. You buy 100 contracts of Nifty 50. If the Nifty price rises, you will profit; if the price falls, you will incur a loss.
Commodity Futures
Now let’s talk about the second type of futures trading: commodity futures. This is a contract in which you can place bets on the future prices of raw materials such as gold, oil, or wheat. You should know that commodities include metals like gold, silver, and copper; agricultural products like wheat, corn, and cotton; livestock; softs like sugar and rubber; and oil, natural gas, and coal.
To place bets on commodities or make predictions about them, you agree today to buy or sell that raw material at a fixed price in the future. If your prediction is correct about whether the price will rise or fall, you can make money; if your prediction is wrong, you can lose money.
For example, a petrol pump owner thinks the price of petrol will rise next month. He doesn’t want to stock up on a lot of petrol today but wants to buy petrol at a lower price in the future. So he buys a futures contract, meaning he agrees to buy petrol on a fixed date at a fixed price next month.
If the price of petrol rises, the petrol pump owner can sell the contract at the market price and earn a profit. However, if his prediction or bet is wrong and the price of petrol decreases instead of increasing, he will have to buy petrol at the price he agreed upon, even if the market price is lower. In such a case, he will incur a significant loss.
Thus, commodity futures are also quite risky because the prices of commodities can change for various reasons, leading to incorrect predictions.
Conclusion
In this way, both types of futures trading come with high risks. Traders who understand commodities and wish to bet on them may find commodity futures to be a better option. Traders who want to invest across the entire market and want to keep risks a bit lower may find index futures to be a better option.
Now you have learned what futures trading is, how it works, what its types are, and for whom it may be the best suitable trading practice. So, based on that, you can make a decision.
