Opinion: Should you Start with Equity or Derivatives Trading?

If you're new to the stock market, it can be overwhelming to decide where to start. Two popular options that are commonly available are derivatives trading and equity trading. But which one is best for a newbie? Here's my opinion.

Firstly, let's define what each of these terms means. Equity trading involves buying and selling shares of individual companies on the stock exchange. Derivatives trading, on the other hand, involves contracts that derive their value from underlying assets such as stocks or commodities.

Now that we have an understanding of what they are let’s look at some pros and cons for both:

Equity Trading:

Pros:

1. Easy to understand - Equity trading does not require you to understand various complexities of the derivatives markets such as options greeks, futures pricing models, contango and backwardation, nuances of hedging, dynamic margin system, etc.

2. Less risky - While equities as an asset class is highly volatile, making it quite risky but compared to derivatives, it is more suited to conservative traders as it does not allow you to carry your trades on leverage. So a 2% downtick on equity will be 2% and the same 2% could be upwards of 10% in derivatives due to high leverage.

Cons:

1. Limited returns - As there is no leverage, the returns are also less which makes them less appealing to more ambitious traders, especially the ones who have already witnessed options getting double in value within a few hours.

2. No hedging - As one cannot go short on equities, it is very difficult to hedge your portfolio against a downtrend. Obviously, equity portfolios can be hedged by options and futures but that would require one to dabble in the risky derivatives market.

Derivatives Trading:

Pros:

1. Offers high leverage - The con of equities is the advantage of derivatives trading - Leverage. Due to leverage, traders are able to maximize their gains with the same amount of capital. This is the main attraction for traders to tap derivatives.

2. Hedging - As traders can make short positions in this segment, it is easier to hedge existing portfolios. For eg. a large-cap portfolio can be hedged by buying a put option of the large-cap index, Nifty 50 .

Cons:

1. Complex instruments - While many traders are coming into the F&O segment, most of them do not understand the intricacies of derivatives. There is a steep learning curve here which includes honing hedging skills, understanding the pricing models of these instruments, etc.

2. High risk involved - Leverage is a two-sided sword. If it can amplify your returns, it can also amplify your losses at the same pace. This leverage makes 90% of traders lose money in the stock market as just a 10% move against you on a position with 10x leverage is enough to totally wipe out your capital.

3. Fewer instruments - There is a significantly less number of instruments available here. While there are around 2,000 stocks listed on the NSE, the instruments in the derivatives segment are around 200 and more than half of them aren’t even worth trading due to poor liquidity.

So, should a newbie start with equity or derivatives trading?

In my opinion, if you're just starting out in the stock market world then equity trading is probably your best bet. It's easy to understand, is less risky, and requires less capital as compared to derivatives trading. Additionally, investing in individual companies allows you to learn more about different industries, business models, government policies, etc.

On top of this there are many resources available online that will help guide beginners through their first trades in equities without too much difficulty; making it easier for them to get started quickly whilst minimizing mistakes along the way!

That being said if someone wants more complex investments or higher-profit margins then maybe derivative markets could be worth a look once they've gained experience dealing with simple equities first-hand. However, if someone is very keen to start directly in the derivatives segment, they can look at the currency market. It requires noticeably less capital and the stability of currencies cannot be matched by equities, making the former less riskier.

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