There are numerous trading avenues and strategies for an investor to try out and embrace. One such popular trading strategy is trading in derivatives. In fact, the use of derivatives trading has been around for decades because of its better returns and risk hedging properties. So, if derivatives trading has got you interested, then read on to know the basic facts about it.
What exactly is derivatives trading?
A derivative refers to a contract that takes place between multiple parties, and the value of the contract is based on a particular asset or group of assets. Such assets can be currencies, stocks, commodities, or even exchange rates. Thus, you will find derivative trading elements in share, CFD, or currency trading.
In derivatives trading, you benefit mainly from positive market movements. It is easier for traders because it does not need a heavy capital investment upfront. So, if you keenly watch the global market movements to have a clear understanding, then derivatives trading is for you.
The participants in the derivatives share trading market
The derivatives market can be broadly divided into three types of players –
Arbitrageurs: In this case, traders buy an asset for cheap at one exchange only to sell it for a better price in some other exchange. As you can guess, there is a very small window of opportunity for arbitrageurs.
Hedgers: This group is into CFD trading and derivatives market only to reduce risks.
Traders: These are the ones who operate in the market solely with the aim to take a good position in the desired contract.
The benefits of trading in derivatives
The popularity of trading in derivatives stems from the four main benefits it offers:
- The option to choose risk levels: You can go for a high-risk or conservative strategy based on your trading outlook.
- Better leverage: You get a greater trading exposure in the financial market with a lower margin amount.
- Accessing higher returns: You might get a return even when the market is going down or sideways.
- Hedging the position: There are prospects to keep yourself away from risks by hedging the position.
Different kinds of derivatives to trade
Now, a financial trading consultancy will give you three types of contracts that you can trade in – options, swaps, and forwards. Here’s a brief overview of each:
Options: Options refer to the contracts that offer traders the rights to sell or purchase the underlying asset. This is the chosen route when you want exposure to major price movements minus the position in the asset.
Swaps: In swaps, two parties make an agreement to exchange future cash flows as per a pre-decided formula and agreed-upon norms.
Forwards: Two parties decide to sell or buy an asset at a specific date for a specific price that is determined on the day the contract is signed.
It is important to have an understanding of the market to make derivatives trading work for you. At the same time, your market knowledge will keep improving as you continue to trade more.
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