In this article, we will discuss
Commodities derivatives trading can be challenging for beginners and seasoned traders alike. Since the derivatives market is dynamic and constantly fluctuating, traders need to navigate high levels of volatility in this segment. Furthermore, the movement of options and futures prices is also influenced by the underlying asset or commodity. This adds an extra dimension to futures and options trading in the commodities segment.
Most traders are unaware of the nuances involved in trading commodities derivatives. As a result, they make common yet costly trading mistakes that could lead to significant losses in the market. If you are planning to venture into commodities derivatives trading or if you already trade in commodities derivatives, you need to be aware of the top mistakes to avoid when trading.
5 Common Mistakes in Commodities Derivatives Trading
To ensure that you do not fall prey to the common pitfalls in commodity derivatives trading, check out the common
1. Failing to Use a Stop-Loss Order
The commodities derivatives market can be extremely volatile. In addition to the factors driving price fluctuations within this market segment, any volatility in the commodities market also spills over into the derivatives market. So, if you are not careful, the price of a contract may rise above or fall below your expectations within seconds. This, in turn, can magnify your losses several times over.
Without a stop-loss order, the risk of incurring losses due to such unexpected and sharp price movements is quite high. A stop-loss order is a trading instruction that ensures a derivative is bought or sold when the price reaches a certain level. It ensures that you can exit a position before it becomes too risky.
How to avoid this mistake:
To avoid this trading mistake, make sure that you always set a stop-loss limit before entering any new position in the commodities derivatives market.
2. Trading Without a Strategy
Entering the commodities derivatives market without a strategy can be an extremely costly trading mistake. Relying on impulses and emotions to make a trade or exit the market can lead to significant losses if you are not careful. A trading strategy is the blueprint required to figure out which commodities derivatives to trade in, what price to buy or sell a security at and how much stop-loss you require.
Without these aspects planned out from the outset, you risk entering the market blind. The lack of a futures or options trading strategy also leaves you unprepared to deal with unexpected market movements.
How to avoid this mistake:
To ensure you do not make this trading mistake, you can make use of strategy builders that help you assess the risk and reward for each trade and plan your entry and exit accordingly. Options BRO from Samco Securities is one of the most effective options strategy builders available to traders today.
When you submit key details like the contract you want to trad e in, its expiry and your market outlook, Options BRO performs extensive calculations and analyses to identify the top 3 strategies for your trade.
If you are a Samco customer, you can use Options BRO free of charge on the Samco trading app.
3. Naked Derivatives Trading
Naked trading in commodities derivatives involves taking a position in the market without having an adequate hedge or protective position to offset any potential risks. Depending on the position you take, such naked trading can expose you to unlimited risks — especially in positions that are highly leveraged.
For instance, say a commodity is trading at Rs. 130 per unit in the market. You expect its price to fall steeply in the next month, so you sell commodities call options with a strike price of Rs. 128. However, by expiry, the price of the commodity moves unexpectedly and hits Rs. 150 per unit instead. This means you will have to endure a loss of Rs. 22 per unit of the commodity in each lot of the options contract.
How to avoid this mistake:
To ensure you avoid this trading mistake, you must prioritise hedging your positions effectively. This protects your capital against adverse price movements. Typically, multi-legged strategies offer the benefit of inherent hedging because of opposing positions that help set off losses more easily.
Samco’s industry-first options strategy builder Options BRO can be a game-changer here. By simply entering a few key details like your preferred scrip, its expiry and your market view, you can sort through and select from hundreds of multi-legged hedging strategies.
4. Inadequate Research
Entering the domain of commodities derivatives trading without performing adequate research is another common trading mistake. Without accurate context of the commodities derivatives you are trading in, you may not fully grasp the nuances of each trade. This, in turn, may lead to poor trading decisions that could be unsuccessful more often than not.
Research is particularly important in this market segment because the prices of commodities derivatives are influenced by several factors like weather patterns, demand, supply, laws and regulations and local developments. Additionally, trading without factoring in crucial aspects like the options Greeks, implied volatility and open interest means that you are almost certainly setting yourself up for losses.
How to avoid this mistake:
To avoid this trading mistake, take some time to research the market segment as well as the commodity whose derivatives you plan to trade in. This will help you make informed trading decisions.
5. Ignoring the Risk-Reward Ratio
Often, you may be so fascinated by the potential profits from a trade that you fail to account for the risks involved. This leads to an unfavourable and skewed risk-reward ratio, where the potential gains do not justify the risks taken to open a position in a commodities derivative. It also means that you may end up taking positions that do not align with your risk tolerance levels.
How to avoid this mistake:
To avoid this pitfall, you need to evaluate the risk-reward ratio of each position before you initiate a trade. Doing this manually can be error-prone and time-consuming. However, with a competent tool like Options BRO from Samco Securities, you can assess each potential strategy and check the risk-reward ratio before placing an order.
Conclusion
Ultimately, commodities derivatives trading has the potential to be profitable if you do your due diligence and take the measures necessary to avoid the trading mistakes outlined above. With Options BRO from Samco, you can steer clear of most of these pitfalls and leverage market opportunities effectively.
Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING. The asset classes and securities quoted in the film are exemplary and are not recommendatory. SAMCO Securities Limited (Formerly known as Samruddhi Stock Brokers Limited): BSE: 935 | NSE: 12135 | MSEI- 31600 | SEBI Reg. No.: INZ000002535 | AMFI Reg. No. 120121 | Depository Participant: CDSL: IN-DP-CDSL-443-2008 CIN No.: U67120MH2004PLC146183 | SAMCO Commodities Limited (Formerly known as Samruddhi Tradecom India Limited) | MCX- 55190 | SEBI Reg. No.: INZ000013932 Registered Address: Samco Securities Limited, 1004 - A, 10th Floor, Naman Midtown - A Wing, Senapati Bapat Marg, Prabhadevi, Mumbai - 400 013, Maharashtra, India. For any complaints Email - grievances@samco.in Research Analysts -SEBI Reg.No.-INHO0O0005847
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