Saturday, November 9, 2013

Derivatives Trading is about managing your risk

Novice traders enter the market, discover derivatives and feel like kids in a chocolate shop.

Derivatives provide leverage which can yield more gains than we imagine. Buy an option for Rs 5,000 and maybe it can go all the way to Rs 50,000. Pay a margin of 14% to buy Index futures and if the Index goes up just 2.8%, the trader has made 20% on his investment(margin paid) in just one or two days.

This is how most new entrants view derivatives - a money tree. The trader believes that all he has to do is learn how to pick the fruits from that tree. That looks very easy and traders spend their time and all their money trying to find the way to pick the harvest from the money tree - they can see it, all they have to do is to get it.

Yet, we know that no one has actually taken anything from the tree.

The reason is easy: derivatives are products of leverage. Leverage is high risk. Therefore, the way to make money from derivatives is to manage your risk. This is a boring task for most new traders. what they like is to get 'picks' - names that will go up or down! What experienced traders do is to focus almost exclusively on the risk that their trades generate.

So, experienced traders make money, while novice traders lose all their money.

If you are trading in derivatives, here is a simple method to manage your risk: your trading capital should be at least three times the margin that you give to the broker. The investment in options should never be more than 15% of the capital that you set aside for options trading (excluding margin).


7 comments:

Sumit Singh said...

As they say "Leveraged market is already risky. You don't enter the leveraged market with risk appetite, you enter with risk management"

deepak agarwal said...

SMALL QUERY

sir,
first of all a great work what you are doing as an analyst
as i am a great fan of your's need help in this subject as i am also belong to the same profession as you are but i am a fresher so i need help
my query to you is of axis bank on 29, October banknifty gave a breakout of 11000 which a strong resistance and 200EMA and on the same day axis bank aslo gave a strong breakout and was strongest on that day but banknifty rallied
but axis didnot though it was strongest of all the banks
i am not able to understand why

please i am waiting for your positive response

student of your passion

deepak agarwal said...

A SMALL QUERY

sir,
first of all a great work what you are doing as an analyst
as i am a great fan of your's need help in this subject as i am also belong to the same profession as you are but i am a fresher so i need help
my query to you is of axis bank on 29, October banknifty gave a breakout of 11000 which a strong resistance and 200EMA and on the same day axis bank aslo gave a strong breakout and was strongest on that day but banknifty rallied
but axis didnot though it was strongest of all the banks
i am not able to understand why

please i am waiting for your positive response

student of your passion

Gourav said...

Priceless advice for a trader.
Thank you Sir...Please continue to write such write-ups in your blog.

Regards
Gourav

Srija Stock Broking Co said...

Sir, What you said is true.

Sandesh Kedia said...

Hats off sir..!

Rajesh Alawadhi said...

Dear Sir,
Here is one compliment for you from my son,just a 5 year old guy.
I was listening to you on CNBC a few days back(btw i only put on cnbc at your time of appearance). This little guy goes to mama and tells that papa is listening to his Sir on Tv. Wondering who is this sir of papa who comes on tv, my wife went to check and by that time you were gone.
Later he told her that there is a sir of papa who comes on market channel and papa does shares after listening to him. Surprisingly he happened to know your name too and called you Sudarshan Uncle.
This is how strong the impact of your presence on lives your followers.Keep guiding and keep posting and stay a source of motivation and Guru to all of us.
Warm Regards
Rajesh