Common Trading Errors
Did You Know that Rich Ilczyszyn, the CEO and founder of iiTRADER.com, concluded that trading futures can be risky because you risk losing more money than you initially invested? Ilczyszyn advises traders to only trade the money they can afford to lose, also termed as “risk capital.”
What is Futures Trading?
Futures are financial derivative contracts. They are agreements between two individuals or entities in which payment is made at a predetermined price and future date. Futures are normally traded and standardised on exchanges. There is no counterparty risk because they are exchange traded. A counterparty risk is the likelihood that the other party in a trading transaction will not carry out their end of the agreement and will not fulfil their contractual obligations. One can settle futures contracts full with either cash or delivery.
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Trading Errors Made in Futures Trading
Taking MTM Margins Lightly
We already are aware of how easy it is for people to enter futures trading. By only paying an initial margin amount, it becomes super easy to enter futures since traders don’t need to worry about paying the entire amount all at once. However, it has its own disadvantages. Let’s say a broker agreed to enter a futures agreement with PNB (Punjab National Bank) for a single lot of 1000 shares. 1000 shares are worth a total of Rs. 8,00,000. A total of Rs. 1,50,000 in initial margin was paid by the broker.
Also Read: What is Risk Profile?
If the price rises to Rs. 50 the next day, the broker will be pleased to earn a profit of Rs. 50,000. But what if the price fell by Rs. 90 overnight? A loss of Rs 90,000 will be incurred by the broker. Then, he or she will have to make up for the loss. The broker will suffer a margin penalty if they are unable to bring in that amount or will be forced to close the position, incurring losses. MTM margins should always be taken seriously, and an arrangement of 35–40% or at least 30% of initial margin should be set aside for MTM losses.
Incorrectly Setting/Using Stop Loss
Stop loss orders are extremely useful for risk-averse traders. Stop loss cannot completely prevent losses, but it does allow you to stop a loss up to a particular amount. A stop-loss order is an order to a trader to purchase or sell a certain stock/security at a specified price This is known as the stop price. If you feel you cannot afford to lose more than Rs. 50,000, put a stop loss order at Rs. 50,000, and the stop loss order will buy/sell the stock the moment you lose Rs.50,000 to prevent you from losing any more. If you have not already set a stop loss, start utilising it!
Stop Overleveraging
When you over leverage in order to gain 10 times the profit of your leverage, you don’t realise how you’re neglecting the 10 times loss you may end up with. This is very common, and many traders have gone into debt as a result of overleveraging. Therefore, before leveraging any money, always check your resources and understand your risk tolerance.
Always following the Crowd
If you don’t already know, arbitrageurs are those who try to benefit from market inefficiencies by buying shares in one market and selling equivalent shares in another simultaneously. Arbitrageurs are limited since they require a huge sum of money and are often major entities that purchase in cash and sell in futures to profit. When you notice excessive or aggressive selling in futures, it may just be the institution creating arbitrage positions.
Do not take it as an indication to sell or short futures, you will wind up incurring losses. This is just a non-directional tactic that is independent of market fluctuations. As a result, rather than merely going with the flow of what everyone else is doing, don’t always follow the crowd and attempt to have a legitimate justification for buying/selling the stock.
Not Being an Active Learner
If you are a trader who is serious about making money. You must be up to date on everything. If you are trading a certain stock, keep up to date on both industry and stock news. Take courses, figure out where you’re doing wrong, and attempt to avoid making common mistakes. Learn fundamental and technical analysis and how to use it in trading. Develop your analytical skills while being an engaged learner.
