The Dangers of F&O, and Small-Cap Stocks
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In this area, one can make money by investing in the market with some wit and proper strategy. In the case of India, retail investors must understand that there are risks and complexities involved in certain types of investments. This article explains why retail investors should avoid futures, options, and Small and Medium-Sized Enterprises (SME) stocks in India.
The enormous growth in the F&O trading segment is evidenced by its monthly turnover reaching Rs 8,740 lakh crore in March 2024 from just about Rs 217 lakh crore in March 2019. At the same time, the average daily turnovers for the equity cash and derivatives segments were Rs 1 lakh crore and about Rs 330 lakh crore, respectively.
A SEBI study found that 89% of individual traders in the equity F&O segment made losses, and the average loss was Rs 1.1 lakh in FY22.
Moreover, the study observed an exponential growth in the participation in the F&O segment when the total number of unique individual traders increased from 7.1 lakh during FY19 to 45.24 lakh during FY21.
1. Understanding Futures and Options
1.1 Complexity and Leverage
Financial derivatives, like futures and options, can be great revenue generators, although they are known as high-risk tools due to their complexity and leverage. They're not straightforward instruments but must be executed with an understanding of market movements, timing, and strategy.
Leverage Risks: Trading with futures and options offers the investor an opportunity to have substantial control over a large position with comparably very low levels of capital. This can, however, exacerbate losses and possibly wipe out the whole of an investment and more.
Complexity: F&O-based strategies are rather complex, with features such as call options, put options, straddles, and spreads. Therefore, it might get difficult for retail investors, who do without the knowledge and experience, to sail this water successfully.
1.2 Market Volatility
The Indian stock market is volatile, with the F&O segment being the most volatile part of it. This has translated into very high amplitudes of price movement within a very short period, which makes it very hard for the retail investor to predict and react in time.
Highly Volatile: The F&O markets change very quickly and unpredictably due to a series of influences coming from the economic news, geopolitical events, and market sentiment. Such unpredictability may translate into high losses.
Emotional Stress: The dynamism involved in F&O trading can make decisions emotional, leading investors to act on impulse because of fear or greed, which further aggravates losses.
2. Challenges for the SME Stocks
2.1 Lack of information and transparency
Stocks of small and medium-sized enterprises, constituting SME stocks, often are attractive due to some growth potential, although they have their challenges.
Lack of Transparency: In most cases, the amount of public information is usually very minimal for SMEs compared to larger and established companies. The non-transparency aspect makes it almost impossible for retail investors to conduct intense due diligence to reach better decisions.
Financial Stability: The SME sector lacks the volume to stand as strongly concerning financial stability as bigger companies, so it is vulnerable and easily shattered when economic storms arise or issues in operational procedure challenge it.
2.2 Lack of Liquidity
Liquidity is the extent to which an asset can be acquired or disposed of in the market without affecting its market value. By and large, SME stocks tend to suffer from low liquidity—a big risk that investors usually face. Exit Position Difficulty: The level of liquidity is low and hence may make it sometimes hard to sell the stocks of SMEs at desired prices and times. This may result in a huge loss if an investor is compelled to liquidate the position quickly.
Price Manipulation: Illiquid stocks can be highly exposed to price manipulations, where just a couple of huge trades in the market can affect the stock's prices fiercely while bringing unfair advantages to some investors and potential losses to other investors.
3. Conclusion
Besides, these instruments involve a high degree of complexity and risks which are not intended for the average retail investor; therefore, due caution should be observed in India toward futures, options, and SME stocks. Rather, focusing on more traditional and less volatile investment options can provide a more stable and predictable path to financial growth. In other words, Futures and Options: High leverage risks, market volatility, and complexity make this one better to avoid. SME stocks: are best avoided due to a lack of information, transparency, lack of financial stability, and very low liquidity. By not taking such high-risk investment instruments, retail investors can just protect their capital to work toward developing a diversified portfolio that exactly aligns with their financial goal and risk tolerance.