What are derivatives?

Whenever we talk about stock market, we definitely come across options and futures. These are instruments that depend on the future price movements of their underlying assets such as stocks, bonds or commodities. These tools of stock market come in the category of derivatives. Talking about derivatives, it is a contract in a way, which locks the value of an asset in the future. In this post “Derivatives Meaning in Hindi”, we will know in detail what derivatives are, how they are used and why they are so important in the financial world.

What are derivatives?

A derivative is a financial instrument in the stock market that drives its value from another asset. This underlying asset can be stocks, bonds or even commodities or currencies.

The special thing about derivatives is that they are a contract or agreement for the future. Meaning that you agree on a price today and that you will buy or sell that asset at that price in the future, no matter what the market price is. This gives traders a way to avoid market volatility and at the same time, it also gives them a good tool for speculation.

How many types of derivatives are there?

There are mainly 4 types of derivative contracts. These include:

Futures Contracts: These are such contracts which give the right to buy or sell an asset at a fixed price on a fixed date in the future. These are traded on exchanges and are often used to hedge commodities or stocks.

Forwards Contracts: These contracts are similar to futures but they are customized. Their price is negotiated directly between two parties. These are not traded on exchanges and hence have higher counterparty risk.

Options Contracts: Options give you the right, but not the obligation, to buy or sell an asset at a certain price at a certain date in the future. These are of two types:

Call: Right to buy

Put: Right to Sell

Swaps: In a swap, two parties exchange their financial instruments, such as interest rates or currency. It is used to manage interest rates or hedge currency risk.

People participating in derivative trading

There are different types of participants in the derivatives trading market, who operate in the market with their own objectives. These logos include:

Hedgers: Hedgers are investors who use derivative markets to reduce the risk of their investments. For example, suppose you have some shares and you want to avoid loss due to market down. In such a case, you can hedge your risk by using derivatives.

Speculators: Speculators are those traders who try to earn profit by taking risk in the market. These people place their trades by analyzing market trends and price movements and if their predictions are correct then they can earn big profits.

Arbitrageurs: Arbitrageurs include those traders who earn profits by taking advantage of the price differences prevailing in different markets. These people buy an asset at a lower price in one market and sell it at a higher price in another market and thus earn risk-free profits.

Margin Traders: Margin traders are those who trade by borrowing money from the broker. These people can place trades worth more than their capital, but the risk and possibility of loss is equally high.

The main objective of all these partners is to earn profit or to protect their investment. But everyone’s perspective is different. Some people want to earn big profits by taking risks, while some people just want to protect their investments.

How to do derivative trading?

Derivative trading is a financial instrument in which you can trade by predicting future price movements. This is a type of contract in which you take a trade on the future price of an asset, without actually owning that asset. Let us know how we can do derivative trading.

Selection of Broker: To do derivatives trading, you must first have a demat and trading account. For this you will need a good broker who will give you a trading platform to trade in the derivatives market where you can execute your trades.

Do market research: It is very important to do market research before any trade. You can closely study the price trends, historical data, and market news of the asset you trade.

Make a trading plan: Every successful trader has a good trading plan. You will also have to make a trading plan according to your capacity and risk, where you will decide how much risk you will take, what type of derivatives you will trade, and what will be your profit and loss limits.

Practice: If you are new to the stock market then it would be a good decision to practice on a virtual trading account first. With this you can gain trading experience without risking real money.

Trade on a real account: When you feel you are ready, you can start trading with real money. But remember, risk management and maintaining discipline is very important.

Monitor and adjust: You will need to regularly monitor your trading positions and make adjustments to your trading plan as necessary depending on market conditions.

How to learn derivative trading?

Understand the Basics: First of all, you need to understand the basic concepts of derivatives. Derivatives are financial instruments that derive their value from an underlying asset, the most commonly traded instruments being stocks, commodities, currencies, futures and options.

Use of online education: You can get basic and advanced information about derivatives from the educational material available in the market such as books, online courses and webinars. By visiting these sources you can get good information about derivatives for free.

Practice on Virtual Trading Platforms: Virtual trading platforms allow you to practice in real market conditions without risking real money. These platforms help you gain experience in trading and give you confidence.

Develop market analysis and skills: Market analysis is very important for success in derivatives trading. Through technical and fundamental analysis, you can understand the market trend well and take better decisions.

Learn risk management strategies: Risk management is very important in derivative trading. You need to understand how you can manage your trading risk by using stop-loss orders and proper position sizing.

Learn from experienced traders: Strategies and advice from experienced traders can make you aware of the practical side of the market. You can join online discussion forms or be a part of a good mentorship program.

Start small and be patient: Start with paper trading and small trades before you start trading with real money. For paper trading, you can take help of many free apps or websites. Gradually increase your skills and learn to understand the ups and downs of the market and choose the strategy according to the ongoing trend.

Advantages and disadvantages of derivative trading

Derivatives play an important role in the financial market. These have many advantages, such as hedging, which helps protect investors from price fluctuations. Additionally, it is possible to obtain leverage using derivatives, allowing investors to take larger positions by investing small amounts.

Derivatives also provide arbitrage opportunities, where investors can take advantage of market inequities to earn profits. Apart from this, derivatives also help in the process of price discovery in the market, due to which the price of the asset being traded can be accurately estimated.

Talking about losses, one of them is counter party risk, where one party is unable to fulfill its promise. Investors using derivatives may face complexity and higher risk, which increases the possibility of huge losses.

Additionally, misuse of derivatives can lead to market instability, as was seen in the financial crash of 2008. Therefore, it is important to use derivatives correctly and thoughtfully, so that their benefits can be availed and losses can be avoided.

Conclusion

Derivatives are an important part of the stock market and when used properly, they can help you diversify your portfolio and manage risk. Mainly traders use them to manage their risk and trade by estimating the direction of the market. We have many benefits from these but also remember that investing in derivatives comes in the category of high risk and it requires knowledge and experience. Therefore, if you are new to derivatives, do your research first and seek advice from a financial advisor if necessary.