Forward and futures contract (last part)
Since the Global Financial Crisis, the financial world has been in turmoil. It has been a wild ride with markets up, down, up and then down. Investors seek ways to alleviate the risk of this volatile environment. Derivative trading is the answer. Whether it is futures contract or option trading is the choice that we all have.
This is the final part of the futures editorials and I will commence on the options trading in my next series.When we talk about derivatives, there are many instruments that fall into this category. Alternative investments (through an endowment-styled approach), forward contracts, swaps, options, derivatives and futures are among the weapons in a trading.
But what can you and I do if these instruments may seem complicated?
The classic hedge is most commonly by traders who hold positions in stocks. This method of hedging is known as the “pairs trade” as it involves taking an opposite position in a different security of the same sector to reduce risk. If you are bullish meaning you have a long position in a stock and you want to reduce downside risk, you will have to short another stock. If you are bearish in a stock, and you want to reduce upside risk, you will have to go long on another stock.
If you are long a position in XYZ, you will want to choose another competitor in that same sector. This is to protect from industry risk, as most of the stocks of one sector will follow each other in large market movements. If you choose a stock from a different sector, the reliability of your hedge will be reduced as some sectors are negatively correlative (as you may or may not have seen with gold stocks recently).
Talk to FS Securities regarding trading futures. Next editorial will be on options.Share