Derivative trading has grown in popularity since the 1980s, and investors can now trade derivatives on a wide range of financial markets.
Derivatives are some of the most popular trading products in the world and can be used to hedge a position, speculate on the directional movement of an underlying asset, or give leverage to holdings.
As leverage can increase their potential risks and rewards, there are quite a few important things to know before getting started. However, if you are ready to trade derivatives follow our quick guide below.
How to Trade Derivatives – Quick Guide
- Select the types of derivatives you want to trade: Choose between spot and futures prices of over 2,100 derivatives on stocks, indices, commodities, bonds, funds, currencies, and cryptocurrencies.
- Make a trading plan: Decide whether you would like to go ‘long’ or ‘short’ - and how you're going to manage your risk.
- Open a live account: Fill in our online form to start trading derivatives with a regulated broker and award-winning platform.
For a more comprehensive overview of what a derivative contract is, how derivatives are traded, the types of derivative products that you can trade, and an overview of some of the risks and benefits involved, follow our in-depth guide below.
What are Derivatives?
A derivative contract is a contract between two or more parties where the derivative value is based upon an underlying asset like an index, stock, or commodity. The price of the derivative is determined by the price fluctuations of the underlying asset.
Derivatives can be traded on an exchange or over the counter (OTC), which means trading through decentralized dealer networks rather than a centralized exchange. You can take a position on a large range of underlying assets, including:
Types of Derivatives
There are several types of derivative products that you can trade, with each of them having significant differences in their details, risks, and benefits. CFDs, forwards, futures, and options are some of the most popular types of derivatives among traders.
However, derivatives like options and futures contracts can be difficult to trade as they often require large capital outlays or accounts with brokers that buy and sell on your behalf.
An alternative is to use a provider like CAPEX.com to speculate on the price movements of a derivative via CFD trading.
CFDs are also a form of derivatives as they track the price of an underlying market. When you trade CFDs, you’re entering into a contract for difference, which is an agreement to exchange the difference between the opening and closing price of your position.
For example, you can take a position on a futures contract listed on an exchange without buying or selling the actual contract. Rather, you’d use a CFD to predict whether the future’s price will rise or fall, based on market conditions. If you think the price will rise, you’d buy (go long) whereas if you think it’d fall, you sell (go short).
While this means you can make a profit or a loss, whatever the market’s doing – based on whether you predicted its movements correctly or not – this form of trading isn’t without risk. Short-selling in particular can bring significant profits or losses, as there’s no limit to how high a market’s price can rise.
CFDs are leveraged forms of trading, meaning that you’ll put up a small initial deposit (called a margin) to open a larger trade. This is a small percentage of the total value of your position. However, both profits and losses are calculated based on the full position size, not your margin amount.
A forward contract involves a buyer and seller. They agree to trade an asset at a future date, but at a price that is agreed upon today. These are traded OTC, with the terms privately agreed between the parties involved. Forwards incur counterparty risk because are traded over the counter.
Futures contracts evolved out of forward contracts and therefore carry many of the same characteristics. The unique aspects of futures contracts are that they are standardized and traded on exchanges. The exchanges guarantee payment, so counterparty risk is lessened. You can trade on futures markets with CAPEX.com using CFDs.
Options give one party the right (but not the obligation) to purchase or sell an asset to the other at a future date at an agreed price. If the contract gives the option for one party to sell an asset it is called a put option. If it gives the option for one party to buy an asset it is called a call option.
What is Derivative Trading?
Derivative trading is when traders speculate on the future price action of an asset via the buying or selling of derivative contracts with the aim of achieving enhanced gains when compared with buying the underlying asset outright. Derivative trading has grown in popularity since the 1980s, and investors can now trade derivatives on a range of financial markets.
Traders can also use derivatives for hedging purposes in order to alleviate risk against an existing position. With derivatives, traders are able to go short when prices are topping out or falling and hedge against any existing long positions.
You can trade on thousands of financial instruments with a CFD broker like CAPEX.com via derivatives, which are explained in further detail below.
Derivative trading in the stock market
You can trade on the price movements of stocks through CFDs. CAPEX.com platform offers you the opportunity to trade derivatives on thousands of shares. You can also trade derivatives on exchange-traded funds (ETFs). These are investment funds that hold a collection of underlying assets, such as shares, commodities, and bonds.
Currency derivatives trading
With CAPEX.com, you can get exposure to over 50 currency pairs through CFDs, which is one of the most popular ways to enter the foreign exchange market, the largest financial market in the world. You can also trade derivatives on the US Dollar Index which is a relative measure of the U.S. dollar (USD) strength against a basket of six influential currencies.
Commodity derivatives trading
Traders can use CFDs on a wide range of commodities, which are categorized into either hard or soft varieties. Examples of hard commodities include natural resources like gold and oil, whereas soft commodities are agricultural products, like wheat and coffee.
Cryptocurrency derivatives trading
Crypto derivatives are trading instruments that allow hedging an existing crypto portfolio or speculation on rising or falling prices without needing an exchange or wallet. With CAPEX.com you can also trade the first Bitcoin ETF listed on the exchanges.
Why Trade Derivatives?
For businesses, derivatives play a vital role in the financial system by acting as a form of insurance through the hedging process, allowing them to avoid negative price movements and mitigate losses, regardless of which way prices move.
For individuals, derivatives allow trading in the likes of stocks, currencies, commodities, and cryptocurrencies without having to actually buy or even store them. This allows derivatives trading to center on and is settled in cash, without the actual asset having to be delivered.
The beauty of speculation is that you don’t have to take ownership of anything, but can still make a profit (or a loss) on various financial assets, simply by making a prediction on the market direction. You’d either buy or sell derivatives in the hope of your prediction being correct.
For example, if you think the gold price is set to rise over the coming weeks, you could buy CFDs on Gold. If, however, you think the gold ounce may depreciate in price, you’d sell (go short) with CFDs.
To make better-informed derivatives trading decisions, consider the following market outlooks:
Traders, investors, or businesses can also use derivatives for hedging purposes, which means opening a second position that will become profitable if another of your positions starts to make a loss. In this way, you can mitigate your risk by gaining some profit and limit your losses overall, without having to close your initial position.
For example, you think the price of Brent Crude may go down, so you want to hedge your portfolio of oil stocks or oil ETFs with us using CFDs. So, you go short on 10 Brent Crude oil CFD contracts. CFDs are calculated based on the difference between the market price when you open your position vs when you close it, and a single standard Brent Crude oil contract is equal to $10 per point.
So, for each point the Brent Crude price falls, you’d make $100 ($10 multiplied by 10 contracts). Likewise, for every point that the oil price appreciates, you’d make a $100 loss.
Leverage in Derivatives Trading
Trading with leverage on derivatives involves entering into a buy or sell position and speculating on which way their chosen market will move, using a reasonably small margin/deposit. Without the investor actually owning the underlying asset, their profits or losses will correlate with the performance of the market. However, leverage will cause these profits/losses to be magnified when compared with buying the underlying asset outright.
To help manage risks in trading leveraged derivatives, it is important to plan a trading strategy in advance. A popular risk-management tool traders can use when trading with leverage is a stop-loss. By implementing a stop-loss order to a position, a trader can limit losses if the chosen market shifts in an unfavorable direction.
However, it is important to be aware of potential risks, such as the market experiencing a negative short-term fluctuation, which could activate the stop loss order before the market conditions improve again. Also, during high volatility, slippage can occur, which means when a market order is executed or a stop loss closes the position at a different rate than set in the order.
Derivatives Trading Strategies
With derivative trading, having a trading strategy is critical in deciding your entry and exit points. It is important to fix a plan that is built to achieve gains, limit losses, and manage risk as much as possible.
Short-term traders such as day traders focus more on technical analysis, following trends that arise throughout the day in short periods with the aim to gain from short-term price movements. There are several well-known strategies for short-term traders, such as scalping, which is where traders aim to make a profit from small price fluctuations, before and after executing a trade.
Long-term trading involves holding on to a position for longer periods. Long-term traders make decisions based more on fundamental analysis and economic indicators that mainly focus on how the market will look in the future. Position trading is a popular long-term strategy, which enables traders to hold a position for a long period of time. Without concerning themselves with shorter-term trend movements, position traders’ focus is on the long-term objective.
How to trade in the derivatives market with CAPEX.com
You can trade derivatives with us in a number of ways. Whether OTC or on-exchange, derivatives trading requires large capital outlays and a brokerage account – which is why traders rather use a platform like ours. With us, you can access 2,100+ leveraged instruments.
Our award-winning platform has a wide range of exclusive trading tools and technical features that we offer to aid your derivative trading strategies.
Once you have registered for an account, you can start to trade financial derivatives instruments, which are displayed on our platform based on the asset class. We also have some pre-determined categories that are exclusive to the platform, such as the biggest risers and fallers of the day in price. Our ‘Top Volatile’ feature is updated hourly with financial instruments whose recent trade volume has increased significantly versus the monthly average.
To take a position in a derivatives market:
Before you start trading derivatives, you should consider using the educational resources we offer like CAPEX Academy or a demo trading account. CAPEX Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more informed investment decisions.
Our demo account is a suitable place for you to learn more about derivatives trading, and you’ll be able to get an intimate understanding of how trading and investing work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to financial derivatives instruments.