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8 things to remember when trading in Nifty Futures

11 Sep 2023

Trading in Nifty futures is a common proxy for trading the market as a whole since the Nifty is fairly representative of the market in particular and the economy in general. Nifty futures are essentially futures contracts on the Nifty. When you trade in a Nifty future, you have obviously taken into consideration the state of the economy and other factors. The minimum lot size of the Nifty is 75 units which makes the lot value at a little over Rs.7.50 lakhs. What are the tips for trading in Nifty futures and what are the Nifty futures trading techniques? Let us understand some points to remember which will help us on how to trade Nifty futures intraday and for the longer term.

In the world of The Indian derivatives market, the Nifty Futures has a very special role to play. This is the most widely traded marketplace for trading in futures instruments, and features the most liquidity in terms of futures contracts. In fact, it may surprise you to know that the Nifty Futures is likely among the leading ten index futures contracts worldwide. Once you are comfortable in the niche of futures trading, you will be active in trading in the Nifty Futures, knowing about terms like “Nifty future share price”, and other commonly used expressions. If you are already well-versed with the basics, you can proceed to know about the Nifty Futures, and keep some things in mind before you trade in earnest. 

A Brief Lesson on Nifty Futures

As you may already know, the futures instrument implies a derivative contract. It derives its own value from any underlying asset. In the context of Nifty futures, the asset which is underlying is the index itself. Therefore, the Nifty futures gets its value out of the Nifty Index. Hence, if the price of the Nifty Index increases, the value of the Nifty futures also rises. In the same way, with any drop in the index, there will be a drop in the futures. 

If you are still a little flummoxed about the Nifty itself, a few basics might help you. As with the Sensex, the Nifty is also a famous equity index. The Nifty is fundamentally made up of fifty stocks. These are stocks of fifty companies which are mainly from the sectors of banking and finance, services, telecom, metals, automobiles, pharmaceuticals, etc. The Finance sector accounts for 40.39% of the weight of the Nifty. It is important, here, to note an aspect of the Nifty called “Bank Nifty”. This is an index that is composed of the largest capitalised and liquid Indian banking shares and stocks. There are a total of twelve stocks from the Indian banking sector, each having a Bank Nifty lot size. 

Check the futures spread over spot before trading 

Futures normally trade at a spread over the spot price. Under normal conditions, the monthly spread over the spot price is determined by the prevailing cost of funds. It is also called the cost of carry and futures normally quote at a premium. There are two things you need to remember here. Don’t buy Nifty futures when Nifty future share price is at a steep premium to the spot index as it could be a case of overpricing and too much optimism. Also don’t jump in to buy when the Nifty futures are at a discount as it could be a sign of aggressive futures selling. Understand the logic of the spread before trading Nifty futures. This could be profitable for you, rather than risking some losses that you may be able to ill afford. 

This is a leveraged position and you must treat it accordingly 

Nifty futures are leveraged like all futures positions, whether bank nifty future positions, or otherwise. When you buy one lot of Nifty in the near month, your margin is around 10% for normal trades and 5% for MIS (intraday) trades. That means you get 10 times leveraged in a normal trade and 20 times leverage in intraday trades. This works both ways. Leverage means that your profits can get multiplied but losses can also get multiplied. Hence any trading in Nifty futures has to be done with strict stop losses and profit targets. These help to mitigate any potential risks. If you are a risk-averse investor, it is especially important to trade with profit targets that are focused and stop loss orders. 

Check data on open interest before taking a position

It always pays to do some scientific data analysis before taking a Nifty futures position. Doing some hard data analysis can prove to be fruitful in your trades in the Nifty. A quick look at the open interest of the Nifty futures and its accumulation trends will give you an idea of whether the open interest is building on the long side or the short side. You can take a more informed view on the Nifty direction.

Avoid getting in a liquidity trap

If you are interested in liquid markets, the Nifty is for you. Liquidity is never a major challenge for the Nifty futures as it is one of the most liquid contracts but there are occasions when the Nifty futures can get into your liquidity trap. Firstly, on the expiry day you will normally find the volumes on the Nifty futures vanishing once the rollovers are substantially completed. Also, in a market that is falling very sharply, the spreads can widen substantially increasing your risk in trading Nifty futures.

There are multiple margin implications

Whether you buy Nifty futures or you sell Nifty futures, it is a linear position as it can lead to unlimited profits and losses both sides. While stop losses are a must when trading the Nifty, one also needs to understand the margins. Firstly, there is an initial margin you pay at the time of taking the position which includes the VAR margin and the ELM margins. Now it is mandatory for brokers to collect both these margins and ELM is no longer optional. Secondly, on a daily basis you need to pay MTM (mark to market) margins based on the price movement. These have capital allocation implications for you.

Beware the overnight risk in Nifty futures

Even if you put stop losses during the day, these orders will not cover your overnight risk. In case you have chosen a long position on any Nifty futures, you may run the risk of overnight trading, leading to losses. For example, if you are long on the Nifty Futures and due to a crash in the Dow if the Nifty crashes by 200 points on opening, what do you do? Stop losses don’t work and you are exposed to the overnight risk in Nifty futures.

Understand the trade from the counterparty perspective

This is an interesting aspect of Nifty futures trading. When you are buying Nifty futures then there is another party that is selling and the same logic applies when you are selling Nifty futures. The other party could be a trader or a hedger and the open interest data will give you necessary insights. While you are normally driven by your view on the Nifty, it always pays to understand the counter view as it can give you greater clarity in your Nifty view. Here, one must know 8 things to remember when trading in Nifty Futures

Keep a tab on the dividends, transactions costs and tax implications

When you trade on Nifty futures, remember that you are committing real money and hence three aspects are important. Firstly, futures don’t earn dividends and hence dividends lead to futures quoting at a discount. Factor this when taking a position. Secondly, when you trade Nifty futures, there are implications of brokerage and statutory costs. This makes a difference to your breakeven. Lastly, Nifty futures are treated as securities for tax purposes so any profit or loss will be treated as a capital gain or a capital loss and the tax implications will apply accordingly.

The key criteria for a stock to be listed in the Nifty Index is that it should be listed on the National Stock Exchange or NSE. Furthermore, the stock of any company listed on the Nifty should be available for trading in the segment of futures and options. Trading in Nifty Futures can benefit you as you trade with India’s corporate leaders. The companies are specially selected for their upstanding histories in the Indian market, in different sectors of Indian industry. 

Related Articles: Nifty Hits an All-Time High | Five trading rules to follow with Nifty at its peak | Does the Nifty performance correlate to the INR USD movement?


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