F and O Trading Tips Online
18 January, 2024
What are F&O contracts?
Futures and options (F&O) contracts are derivative contracts that are traded widely in the stock markets. A derivative contract derives its value from the price of an underlying asset. Such financial instruments do not have any real value and are considered volatile.
F&O contracts traded on exchanges have standardised lot sizes and expiry dates. They do not suffer any counterparty risk, as the clearing house acts as the counterparty on both legs of the transaction. Yet, due to their volatile pricing, F&O contracts are deemed a risky asset class.
Hence, it is crucial to know some futures and options trading tips that can help you become profitable in the long run.
How to trade in F&O: important elements
You might decide to indulge in F&O trading based on your risk appetite. To become a successful trader, you should have a disciplined trading setup. You can get profitable with proper planning, execution and experience.
The following are some key elements that you should keep in mind for devising a successful trading plan -
Expectation management - Managing your expectations within the stock market is of utmost importance. Evaluating your profile and risk tolerance will guide you in determining your market aspirations. Define your financial objectives and assess the level of risk you are willing to undertake to achieve them.
For example, you might choose to have numerous trades with smaller targets or positional trades with relatively larger targets. Such choices will depend on your experience, risk appetite, lifestyle, etc. Approaching the market with realistic expectations is necessary for every successful trader.Risk management - A good trader is one who not only makes a profit but also knows how to limit their risk effectively. Owing to market volatility, a few bad trades can wipe out the entire profit earned over some time.
You must create a risk management system based on how much risk you can take per trade. The amount may vary with your confidence in that particular trade. Irrespective of that, there has to be a risk limit to it. You can ensure limited risks by setting stop losses for the trade. A stop loss refers to the unfavourable price level beyond which a trader would not keep their positions open.Setup - It's necessary to establish a setup that suits your needs. A setup can encompass various types of stock analyses, giving you the confidence to engage in trading. Having a setup assists you in comprehending what is effective and what is not in your trading approach.
By repeating a setup over time, you can refine it basis your experience. Mastering a trade setup goes a long way in making someone a profitable trader.Position sizing - Position sizing refers to deciding what portion of your trading capital you are willing to use for any particular trade. It is typically a function of your dedicated capital and the maximum risk you are willing to take per trade. The size of the position can vary with market dynamics and your confidence in the trade.
It is important to have sizing rules, as you should not 'put all their eggs in one basket'. Being able to create multiple positions helps you diversify and reduce your overall risk.Hedging - Irrespective of your confidence in any trade, it is crucial to hedge for the risk it carries. Hedging helps you remain profitable in the long run as it allows you to limit your losses whenever markets take an unexpected turn. Options contracts are typically used for hedging.
For example, if you buy a futures contract of Nifty 50, you can hedge the risk of downfall by purchasing a put option of Nifty 50. Now, if the prices of Nifty 50 tend to fall, the premium of your put option will increase, partially offsetting the loss arising from the futures contract.
Entry and exit criteria - A good trading plan should encompass rules for entering into new trades and exiting open positions. After entering into a trade, the overall setup of the market might change. In such cases, the presence of exit criteria helps. If such criteria are followed with discipline, then you can eliminate the risk of trading on emotions.
Time frame - Just like the rest of the financial securities, it is crucial to decide what timeframe you are looking at for a particular F&O trade. The time frame of the trade can vary from a few minutes to weeks. It helps in analysis and formulating strategies.
Such a decision depends on your style of trading and market volatility. Typically, traders with a shorter time frame tend to have smaller targets with numerous trades against the ones who take positional trades.Choice of instrument - Whether to go for futures trading, options trading or both is another decision you need to make while formulating a strategy. Each comes with its own pros and cons, and it is crucial to understand them. As a trader, you can also decide to trade only in index F&Os, stock F&Os or both, basis your risk appetite.
It is crucial to know there is no right or wrong plan. It all boils down to what works best for you, basis your profile, expectations and risk appetite.
Conclusion
We hope this article has provided you with all the aspects you need to think of while approaching the F&O segment. Derivatives are volatile contracts but have huge upside potential, thus making them lucrative.
Just choosing the right trades is not enough, you must also select the right account to trade. You can choose to open HDFC Bank's unique 4-in-1 account. This account allows you to manage all your Trades, Savings, Current and Loan Account activities from a single account.
Remember that investments in the market are subject to risk. Hence, you should always conduct proper research before investing!
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*Terms and conditions apply. This is an information communication from HDFC Bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.
