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Risk mitigation part one futures

ICICI Securities 05 Aug 2022

Good investing is not about making good decisions. It’s about consistently not screwing up, says the book – The Psychology of Money.

If the author had to sum up financial success in one word, it would be "survival," he writes. When it comes to producing money, the capacity to stick around for a long time without wiping out or being forced to give up makes all the difference.

The book further explicitly explains the difference between getting money and keeping money. Getting money is associated with taking risks, being optimistic, and putting yourself right there. On the other hand, keeping money requires the opposite of taking risks. It necessitates humility and the fear of losing everything you've built.

Let us assume – you want to get out of the house. You start by keeping an eye on the weather. When you take a look outside and notice that it is cloudy, you decide to embrace the possibility of rain. You can't control the weather, but you can at least analyze the risk. You determine the severity of the risk by consulting the weather forecast, which indicates a 70% likelihood of rain. So you decide to bring an umbrella along. Once you've monitored, detected, and analyzed the risk, your umbrella mitigates the consequences of getting drenched in the rain.

Therefore, in a risk mitigation strategy, you define the risks, predict the repercussions, and devise strategies to mitigate the outcomes. A risk scorecard for every risk object in your network can help you support your risk mitigation activities in a similar way. The answer to- how to recover the losses, maximize capitals and optimize returns in itself lies in ‘Risk Mitigation’.

Risk Mitigation

Risk Mitigation is an integral part of investment in the stock market. Historically, traders have faced a lot of risk at every step in all the transactions. Investing in the stock market has always been a high-risk, high-reward proposition. This is due to the fact that when the economy is doing well, the underlying firms perform better and their common stock or shares grow in value.

There are various unfavorable aspects that might harm a firm, such as obsolete technology, unexpected competition, or inept management. Some global and country-level economic variables, such as recession, conflict, and trade wars, may have a detrimental impact on the stock market as a whole. Therefore, Risk Mitigations play a vital role for the traders in overcoming their losses incurred and maximizing their capital while trading.

Derivatives:

Derivatives give customers a high potential of earning with very low leverage. Hence, with derivatives, customers can ensure to mitigate the risk and generate decent returns. However, there is another side to this story as well. Derivatives can also prove to be of a great loss if the trades do not turn in your favour.            

The primary feature of the derivatives market is ‘Future Trading’. In simpler terms, futures are contracts to buy or sell a particular quantity of a stock, investment, or commodity at a predetermined price on a future date. These legally binding agreements are known as "futures contracts." A commodity trader purchasing coffee bean futures, for example, is literally purchasing a number of coffee beans. So, if the price of Arabica rises, those beans become more valuable, and the investor profits.

How can Derivatives help in Risk Mitigation?

Derivatives are commonly traded to hedge (lower risk) or speculate (scale-up risk with the goal of making a profit), and their value is determined by the supply and demand for the underlying asset. Hedging is a risk mitigation approach that involves acquiring an opposing position in a comparable asset to balance investment losses. Hedging often reduces possible gains while lowering risk. Hedging entails, the payment of a premium in exchange for the protection it provides.

At the same time, the futures market helps to mitigate risk across a wide range of industries. The investors of futures buy a contract against future prices, buying now and profiting if prices rise. They have the option of investing in either commodities or financial products.

Trading in Futures can be as simple as predicting in real life. For example – while playing cards, you predict every move by the other player and play a smart move.  According to that, you take a call about the next moves in the game.

Disclaimer:

ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Mr. Anoop Goyal, Contact number: 022-40701000, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.

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