InvestorQ : How to go about designing a futures trading strategy?
Nikita Damle made post

How to go about designing a futures trading strategy?

Ayushi Kampani answered.
3 years ago

Look at the maximum loss you are willing to take. That is where it all begins. Design your stop losses and overnight risk management based on that. Any open position should always have a stop loss level set at any point of time so that in the event of sudden movements, you have a grasp of what you are exposed to!

Check for liquidity and the spreads in the market. Before entering into a futures trade ensure that there is sufficient open interest built up. In stock futures it is a sign of arbitrage interest. That will ensure that there is constant liquidity availability at most price points. Ensure you do not get stuck! Liquidity is the key to futures trading and you must never get into futures contracts that are illiquid.

Dealing with premiums and discounts are critical. Futures quoting at steep discount could be due to dividends or short build-up. Understand why it is happening. Premiums are normally bullish signals but it could be due to excess selling in cash equities. Be clear about the reasons. Don’t start with the belief that futures at discount to spot are underpriced and futures at premium to spot are overpriced. That is not the way it works.

You are as good as the profits you book on your futures position. Keep diligent profit targets and keep taking profit. You are into futures for the short term. You must roll over a position only if the trend of the stock justifies paying the premium and transaction cost to roll over your position. At the end of the day; booked profits always scores over book profits. Profit is what you book, because all else is just book profits.

Lot size is critical in a futures trading decision. E.g. Nifty has a lot size of 75 while lower priced stocks have fairly large lot sizes. When a stock like Unitech or J P Infra becomes volatile, the impact on your futures holding tends to get magnified due to the lot size. Be cautious about high lot-size futures! This is very typical of penny stocks that have huge lot sizes, so much so that even a 1 rupee movement can mean a big shift for you.

Finally, don’t ever forget that when you trade futures you are effectively borrowing money. When you buy beyond your means, it is borrowing after all. All the ills and risks that apply to borrowing, also apply to futures trading. Like in borrowing, a futures position needs to be backed by adequate conviction.