Derivatives
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Derivatives
A derivative is a contract between two or more parties that derives its value from the price of an underlying asset, like a commodity. Derivatives are often used as a means to speculate on the underlying’s future price movements, whether up or down, without having to buy the asset itself.
Derivatives trading is when you buy or sell a derivative contract for the purposes of speculation. Because a derivative contract ‘derives’ its value from an underlying market, they enable you to trade on the price movements of that market without you needing to purchase the asset itself – like physical gold. You’d do this in the hope of booking a profit.
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Why trade derivatives?
Here are four reasons why you may want to consider trading derivatives:
- Speculation: 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 FTSE 100 is set to rise over the coming weeks, you could buy CFDs on a FTSE 100 futures contract. If, however, you think the FTSE 100 may depreciate in price, you’d sell (go short) with CFDs.
- Trading rising and falling markets: With derivatives, you can trade both rising and falling markets, meaning you can profit (or make a loss) even in a depressed or volatile economic environment. You’d go ‘long’ if you think the price of an underlying asset will rise; and ‘short’ if you think it’s going to fall. To open a long position, you’d elect to ‘buy’ the market. When going short, you ‘sell’ the market when opening your trade.
- Trading with leverage: You can use derivatives to increase leverage. This enables you to take a position for a fraction of the cost of the position’s total value (for example, using $10 to open a position worth $300). However, be aware that this magnifies the size of both the potential profits and the losses that can be made.
- Hedging: 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.
At Ever Bloom Meridian, we believe in the power of informed investments. With decades of experience and a commitment to personalized solutions, we guide you on the path to financial growth.
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