February 12, 2014

Minimum capital requirement for futures trading

Trading in futures is risky because of the leverage and the effect it has on under capitalised traders and their emotions.

However similar problems do not arise in delivery trades specially when trade size is very small. If your transaction size is say INR 5,000 then you can manage a trade far better than if it was say INR 50,000 or INR 200,000.

This is where position sizing comes in. You should ideally take a trade where your risk per trade does not exceed 1% of your capital. This means if your trading capital is INR 100,000 and you want to buy a stock costing INR 100/- with SL  5% then the quantity you should buy is 1% of 100000/ (5% of 100) = 1000/5 =200 shares. This means your investment will be INR 20,000. If the SL is 10%, then the quantity becomes 100 shares and investment is INR 10000.

Let us extend this example to futures trading where the minimum contract size is INR 200000. The following table shows the price, lot size, investment amount and the SL at 1%. Last 4 columns (TC) then show the trading capital requirements if the SL was 1%, 2%, 5% and 10%.

At the lowest SL, the average trading capital is not surprisingly INR 200000. However at 5% SL which is lowest SL for a positional trade, the trading capital requirement jumps to INR 10 lakhs and at 10% SL (recommended), the capital requirement is INR 20 lakhs.

This means unless you have this kind of capital, you should not trade in futures. It is a different thing that exchanges allow you to trade by putting up a margin og 10-20% of the contract size but unless you have the capital to back you up, you should not be trading in futures.

EDIT: a workaround is to reduce the SL. If you bring this down to 0.5%, the capital requirements drop down to INR 100000. However a small SL also means your trades should be intraday only.

Comments welcome.

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