What is derivative trading and how do I start trading derivatives?

08 Jan 2024

What is Derivative Trading and How to Get Started?

This guide provides insights into derivative contracts, their trading process, and the various types available. Learn how to initiate derivative trading, understanding associated risks and advantages. Discover derivative trading strategies and access our award-winning* Next Generation trading platform.

Understanding Derivative Contracts

Derivative contracts involve agreements between parties, deriving value from an underlying asset like stocks, currencies, or commodities. These contracts can be traded on exchanges or over-the-counter (OTC), offering flexibility through decentralized dealer networks.

How Derivative Trading Works

Derivative trading involves speculating on an asset's future price by buying or selling derivative contracts. Popular since the 1980s, traders can engage in derivatives across various financial markets, including stocks, currencies, and commodities. Derivatives also serve hedging purposes to mitigate risk against existing positions, allowing traders to profit from falling asset prices.

Leverage in Derivative Trading

Trading with leverage on derivatives means taking positions with a small margin/deposit, magnifying profits or losses compared to owning the underlying asset outright. Understanding and managing leverage is crucial for risk management.

Risk Management in Derivative Trading

Planning a trading strategy in advance is essential for risk reduction. Stop-loss orders can be effective tools when trading with leverage, limiting losses if the market moves unfavorably. However, potential risks, such as short-term market fluctuations, should be considered.

Types of Derivatives

Various derivative products are available, each with unique details, risks, and benefits. Spread betting, CFDs, forwards, futures, and options are popular choices among traders.

Spread Betting

Spread betting is a tax-efficient** way to speculate on the price movement of financial instruments without owning the underlying asset. Traders bet on price rises (long position) or falls (short position), with profits or losses based on directional accuracy.

Benefits and Risks of Spread Betting

Spread betting allows margin trading, enabling larger positions. However, risks include potential losses relative to the full position value and market volatility outside normal business hours.

CFD Trading

CFD trading is a leveraged derivative product allowing speculation on short-term price movements. Similar to spread betting, it involves contracts exchanging the price difference between opening and closing prices.

Benefits and Risks of CFD Trading

CFD trading offers the ability to profit from both rising and falling markets. Risks include gapping, and holding costs if positions are held overnight.

Forward Trading

Forward trading involves agreements to trade a financial asset at a future date and specified price. It acts as an alternative to purchasing an asset at the spot price.

Benefits and Risks of Forward Trading

Forward contracts provide protection against unfavorable market movements but can limit gains if the asset becomes more valuable.

Options and Futures

Options give the buyer the right (not obligation) to buy or sell an asset at a set price by a specific date. Futures trading involves exchanging financial instruments as contracts on a futures exchange.

Note: The trading platform discussed offers forward contracts but not options or futures trading.

Derivative Trading Strategies

Effective trading strategies are crucial for derivative trading success. Short-term traders, such as day traders, focus on exploiting daily trends, while long-term traders use fundamental analysis for future market predictions. Position trading is a popular long-term strategy.

Trading Derivatives in Financial Markets

Invstiva provides opportunities to trade derivatives on various financial instruments:

Derivative Trading in the Stock Market: Trade on stock price movements via spread betting and CFDs.
Currency Derivatives Trading: Gain exposure to over 330 currency pairs through spread betting and CFDs.
Commodity Derivatives Trading: Trade commodities like gold, oil, wheat, and
coffee through spread betting and CFDs.

Summary

In summary, derivative trading has surged in popularity, offering investors the opportunity to trade on a diverse array of financial instruments, including stocks, currencies, and commodities. Take the first step by opening a live account to engage in spread betting or CFD trading on our advanced Next Generation trading platform. Explore the advantages of our news and insight tools to stay informed about developments in your preferred assets and industries. Start your derivative trading journey with us today.

Trade with Investiva