The rise of retail trading in derivatives: Balancing growth and investor protection

Key Takeaways

• Retail trading in derivatives has surged worldwide, especially in India, with mixed success.
• A collaborative approach and investor education is required to equip retail traders to compete effectively.
• Regulation, supported by advanced trading technology tools, is key to sustaining this growth.

Retail trading in derivatives has surged globally in recent years, reshaping financial markets and driving significant volumes. Asia, particularly India, has emerged as a major growth hub for retail investors in derivatives. Technological advancements and a growing appetite for diversified financial instruments enabled the trend.

While the rise offers opportunities for democratizing financial markets, it also highlights the risks retail investors face, prompting regulators and market participants to reconsider strategies for balancing growth with investor protection. 

Global surge in retail derivatives trading

According to data shared by the Futures Industry Association (FIA), global derivatives saw a significant surge in the post-COVID years.

Source: https://www.fia.org/fia/etd-tracker

As the data shows, Asia led the growth. The primary driver was India, where retail participation grew from 2% in 2018 to roughly 40% in 2024.

The representative from NSE and BSE shared some reasons for the high volumes in India, namely:

• For tax efficiency reasons, mostly options are traded.
• With a per-transaction average size of US$120, the contract sizes are small.
• Short-dated expiries are available.Limited trade internalization in India, with no accumulation in a central place.

Importantly, participation levels in India represent a small volume compared to the country’s population size. So, there is still tremendous potential for further growth. 

How exchanges are promoting retail participation

Exchanges have taken a mixed approach to promoting retail participation in derivatives. These include:

• Tailored products: Exchanges such as the Singapore Exchange (SGX) and Korea Exchange (KRX) have introduced mini and micro contracts, allowing smaller investments and lower risk exposure.
• Investor education initiatives: Many exchanges offer free educational resources, including webinars, trading simulators, and risk management tools, to equip retail traders with the skills needed to navigate derivatives markets.
• Technology upgrades: Digital platforms with user-friendly interfaces and advanced analytics tools are simplifying trading for new participants.
• Reduced costs: To attract retail traders, fee structures now include discounts on trading smaller contracts, or loyalty programs for frequent traders.

While these measures drive record volumes and expand market participation, they also expose retail investors to significant risks, as seen in the Indian derivatives market.

Conversely, exchanges like Eurex have a low retail participation. Indeed, retail investing in Europe is still biased towards structured products, a trend driven by lots of regulations.

The flip side: High loss rates among retail investors

Retail investors face a steep learning curve in derivatives trading. A 2023 study by the Securities and Exchange Board of India (SEBI) revealed that 90% of retail investors in India incurred net losses in derivatives trading, with an average annual loss of ₹1.1 lakh per individual.

There are five main reasons why retail investors struggle:

1. Complexity of derivatives: Many retail participants lack the necessary knowledge to understand the pricing, volatility, and leverage dynamics of derivatives.
2. Overleveraging: Leverage, while attractive, magnifies both profits and losses. Many investors overexpose themselves, leading to significant financial setbacks.
3. Speculative trading: Instead of using derivatives for hedging, retail investors often engage in speculative trading, driven by short-term market trends and emotions.
4. High competition: Retail investors often compete with institutional players using sophisticated algorithmic trading systems, making it harder to achieve consistent profitability.
5. Frequent trading costs: High transaction volumes and frequent trading can result in cumulative costs that erode potential gains over time.

These challenges underline the importance of creating a balanced ecosystem that fosters growth while safeguarding investors.

The need for a collaborative approach

A collaborative approach involving regulators, exchanges, brokers, and technology providers is essential to ensure sustainable growth in derivatives markets. The role of each is distinctive.

1. Regulators

• Protective measures: Implementing stricter risk management requirements, enhancing disclosures, and mandating educational initiatives can protect retail investors.
• Transparent policies: Regulators must balance rules that safeguard investors without stifling market growth.

2. Exchanges

• Product innovation: Developing smaller, less risky contracts and tools for informed decision-making.
• Investor support: Providing educational programs and real-time analytics for market trends.

3. FCMs and brokers

• Role in safeguarding investors:
  • Educating clients about risks and strategies.
  • Offering pre-trade risk controls, such as limits on speculative trading or alerts for margin levels.
  • Enhancing transparency in costs and risks.
• Using technology:
  • Automated risk monitoring tools to track positions and prevent overleveraging.
  • AI-powered advisory systems to provide tailored recommendations and insights.
  • Digitized onboarding processes with robust KYC and risk profiling to ensure responsible participation.

4. Technology providers

• Enabling better access: Developing intuitive platforms with interactive features for risk management and trading insights.
• Fraud prevention: Using analytics and machine learning to detect irregular trading patterns and prevent market abuse.

India’s regulatory shift: A case study in balancing growth and protection

India’s regulators have taken proactive measures to address the high loss rates among retail investors in derivatives markets. Recent changes include:

• Increased margins: Raising margin requirements to reduce excessive leverage and limit speculative trading.
• Standardized contracts: Introducing simpler, standardized contracts to make trading more accessible and less risky for retail investors.
• Enhanced disclosures: Mandating brokers to provide clear risk disclosures, enabling informed decisions.

While these regulations may temporarily reduce trading volumes, the long-term goal is to rebuild investor confidence, ensuring sustainable participation in the derivatives market. Indian exchanges, including the NSE and BSE, have expressed optimism that these measures will create a more stable and investor-friendly ecosystem over time.

Looking ahead

The rise of retail trading in derivatives is a double-edged sword. It has democratized financial markets but also highlighted the vulnerabilities of inexperienced investors. By fostering a collaborative approach and using technology, market participants can create a balanced ecosystem that drives sustainable growth while safeguarding investors.

In India, the regulatory changes signal a pivotal moment for the derivatives market. While the short-term effects may include lower volumes, the hope is that these steps will instill greater confidence in retail investors, ultimately promoting their participation.

Over the next six months, it will be fascinating to observe how these measures shape the Indian derivatives market and whether they achieve the intended balance between growth and protection.