Risks Involved in Derivative Trading

Who wouldn’t want to strike it rich whether it is in oil or gold or the stock market? However, for the first two you need to put in a lot of money and be very patient to make it. The stock market though, has many options and derivative is just one of them. Yes, investing a small amount of money, you can make it really big if you have the knowledge, guts and a few valuable tips from here and there, or through the grapevine. The risks though, are very high and chances to lose are as good as the chances to gain are.

One can’t simply wish away what happened to California’s Orange County government that lost almost a billion and a half dollars and the now defunct Barings Bank bear testimony to how ill-informed traders can cause utter financial ruin. Maybe George Soros would have a more detailed explanation. Notwithstanding, trading in derivatives cannot be written off just like that. Professional investors and traders know how to get the best out of derivatives. When derivatives are handled properly, a very small investment can help generate profits several times the original investment. However on the negative side, you can lose a lot of money. Within a matter of minutes hundreds of thousands of dollars can just vanish from your account if what you expected to happen did not, after all.

Derivatives have been used to create illusionary value out of nothing. This is probably what attracts gullible investors who know nothing about how derivatives work. They get carried away by the speculative profits they have in mind, not heeding to caution and indulging in a speculative spree that is akin to gambling. As most derivatives are not insured against counter-party risk, the losing party has no recourse. Of course, one could always fall back on US Money reserve to help them out from a tight situation.

Unlike earlier, with advancing technology and proliferation in the use of internet, trading online has become quite popular and is widespread. Trading in derivatives is even more attractive as the investment involved is marginal, though the risks are manifold. Another important point is that derivatives have a certain time period after which they automatically expire. They need to be necessarily bought and sold prior to the expiry date. The time decay risk is the most challenging of all, added to that is the premium that keeps changing as the expiry date approaches closer. Hence they can never be long term investments, and it is always better to exit with a minimum profit at the beginning itself. Derivatives can be bought from the same source from where the regular stocks are purchased – that is any of the brokerage firms. There usually is a brokerage fee that needs to be paid for each lot. Though the investment required is quite low, the losses if your prediction goes wrong, can run up several times just as the profits can too.

The important thing is to that one should venture into trading in derivatives only with sufficient knowledge and having enough money to invest can in no way be the only qualification required. Having half-baked information or relying on market tips from financial consultants, especially those that call themselves experts is never going to work out the way you want it to. Just ask yourself, if they are really that good at it, why on earth would they want to advice you on how to go about it, charging a fee in the process? Would it not be profitable for them to do the business themselves? So, study the market thoroughly, and get an idea how the system works before venturing into something as risky as Derivative trading.

This is a guest post by Mark Bennett of workwelltogether.com, a site that offers savings and current information on great internet and cable deals. Go to www.workwelltogether.com