During the pandemic, Bengaluru-based S G Raja Sekharan decided to try his hand at derivatives trading.

After learning the basics from the internet, he began trading with Rs 20 lakh. Within six months, his capital dwindled to Rs 3 lakh. Raja Sekharan is no novice.

Gamification of derivatives

Axis Mutual Fund recently came out with a report titled ‘Gamification of Indian Equities,’ which dwells on the factors that have contributed to the growing popularity of derivatives. One is the change in contract structure.

Says Ashish Gupta, chief investment officer (CIO), Axis Asset Management Company: “The introduction of shorter duration in options has effectively ‘sachetised’ trading, reducing the capital needed to take on similar risks.”

Derivatives offer the allure of lottery-like returns.

“The effective leverage available on options has increased to as much as 500x,” says Gupta.

Ease of onboarding and the easy interface of new-generation trading apps, according to the report, have also contributed to the rise in derivative volumes.  

Finfluencers have also played a part. Says Shrey Jain, founder and chief executive officer (CEO), SAS Online: “They have conveyed the impression to youngsters that trading is easy.” Many online trading apps also nudge customers to trade more.

Investors have mistaken luck for skill. Says Ankur Kapur, investment advisor, Plutus Capital:

“In 2020, as interest rates were reduced, the equity market boomed. A lot of people made easy money that year. The 2022 downturn was also not very severe in the Indian market, so investors who entered the markets during the pandemic have not received a reality check.”

Generally, however, the majority of investors who venture into futures and options (F&O) end up making losses. A study by the Securities and Exchange Board of India (Sebi) found that 89 per cent of investors lose money and only 11 per cent make money in this segment.

Risk from leverage      

The primary source of risk in F&O is leverage. Says Gupta “Due to leverage, while dealing in futures and selling options, there is the risk that the loss may be much more than the initial capital put up by an individual. Even when buying options, while the maximum loss is restricted to the capital deployed, the limited life of options coupled with leverage can result in significant erosion of capital.”

Many people borrow money to trade in F&O.

“This can be disastrous for their finances,” says Kapur.
 

Prepare before you dive in  

Trading should be approached like any other profession. Says Jain: “Learn the ropes and gather experience. Do paper trading first, then stress test your strategy in the market with a small amount. If it works, then raise your stake gradually.”

He emphasises the need for a well-formulated strategy. “Set stop losses, learn position sizing (how much of one’s capital to deploy in each trade), and adopt risk management practices like hedging.”

Raja Sekharan suggests keeping a tight rein on emotions. “If you are on the wrong side of the trade and are making losses, exit. Don’t ever think you are right and the market is wrong. And when you are on the right side of the trade, try not to exit in a hurry.”

Do not risk too much of your capital in a game where you are pitted against large institutional players, professionals, and increasingly, algorithms. Bet only an amount whose loss will not destabilise your finances.

New investors should start their journey in equities with an index fund. Says Gupta: “Investing systematically in mutual funds for the long term is the most appropriate way to create wealth.”  

After he incurred losses, Raja Sekharan found a mentor and learned the nuances of F&O trading. He ploughed in more capital. Over the past three years, he has managed to recoup his losses. Enter the F&O segment only if you have this kind of aptitude for learning and the financial wherewithal to bounce back after a setback.