Things to Remember When Trading in Nifty Futures
While trading in derivative contracts such as futures and options can be risky but rewarding at the same time, this is why these types of trading are suitable for traders who have experience and who know the market in and out.
Because Nifty is an index, it is far more liquid than stocks. This ensures that the entry and exit are hassle-free and easy. However, before you start trading in Nifty futures, there are some things that you need to know.
Top Things to Remember When Trading in Nifty Futures
Here are the top things to remember as a Nifty trader when you start trading in Nifty futures:
- Review the futures spread over the spot price
Typically, Nifty futures tend to trade with a spread over the spot price. The monthly spread over the spot price is determined by the current cost of funds. This is also known as the cost of carry, and the futures are mostly stated at a premium. Therefore, do not buy Nifty futures when these are being traded at a significantly higher premium to the spot index, as this could mean overpricing and excessive optimism. Also, do not hurry in buying the Nifty futures even if they are being traded at a discount, as that can mean overselling. Therefore, understanding the logic of the spread is essential.
- Keep a check on the data related to open interest
Before you start trading in Nifty futures, it is important to conduct a scientific analysis. It is essential to check the data available on the open interest and the trends of accumulation. This will help you understand whether the accumulation of the open interest is taking place on the short side or the long side. It is vital to understand the direction of Nifty to make an informed decision.
- Consider it as a leveraged position
Nifty futures, similar to other kinds of futures, are leveraged. When it comes to leverage, it can work in any direction. You can make profits with leverage, but there are also high chances of losses. Therefore, when you trade in Nifty futures, it is important to do so with strict stop losses and with targeted profits in mind.
- Avoid liquidity traps
Nifty futures might put you into a liquidity trap during certain times. Typically when the rollovers are significantly executed on the expiration date, the Nifty futures volume tends to diminish or completely vanish. Also, when there is a sharp fall in the market, there can be a significant widening in the spreads, enhancing the risk of trading in Nifty futures.
- Stay cautious regarding the overnight risk
Although you can place stop losses during the day, there is no such thing available during the night or the after market hours. In case the futures crash after market hours, the stop losses will be ineffective. Therefore, you cannot avoid the overnight risk that is involved in the trading of Nifty futures, so ensure that you account for it.
- Understand the margin implications
When you sell and buy Nifty futures, you can experience unlimited gains and losses. Although stop losses are an important consideration, you also need to consider the margins. Firstly, you need to pay an initial margin when you open your position; this includes the VAR and ELM margins. Also, you need to pay the mark to market margin, which depends on the daily price movements. Thus, these will affect your capital allocation.
So, these are the top things that you must remember when you are trading in Nifty futures. It is advisable to refrain from trading in Nifty futures on the expiry date. This is because the volatility would be higher due to the squaring off positions and rollovers. Therefore, you might get stuck in open positions.
Also Read: How to Invest in Nifty Index Fund?
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Frequently Asked Questions
Nifty futures contract consists of two options:
- Call option- In this, the owner has the option to buy the Nifty index at a price mentioned in the contract as per the stipulated time frame. But, executing the trade is not an obligation.
- Put option- This is the opposite of the call option, the owner has the option of selling the nifty index at the predetermined price, but he is not obligated to do so.
Some of the most important things that you need to keep in mind as a Nifty trader are reviewing the futures spread over the spot price, keeping a check on the open interest, avoiding liquidity traps, and understanding the margin implications.
Because of the leverage involved in trading futures, Nifty futures tend to be riskier than some other investment options. But, it can also prove to be rewarding. So, it is essential to keep important information in mind before you trade in Nifty futures.