Why 93% of Retail Investors Face Losses in Equity Derivatives: Unpacking SEBI’s Alarming Report

Retail investors have long been attracted to equity derivatives, especially in futures and options (F&O) trading, hoping for quick financial gains. Yet, a recent report by the Securities and Exchange Board of India (SEBI) offers a startling reality check: 93% of retail investors suffered significant financial losses in this market between FY22 and FY24. What’s more alarming is that these losses amounted to a staggering ₹1.8 lakh crores over three years. In this article, we’ll explore the reasons behind these massive losses and offer insights into how retail investors can better protect themselves.

Table of Contents

The Appeal of Futures and Options: Too Good to Be True?

The allure of equity derivatives is rooted in the promise of high returns with relatively low initial capital. Futures and options enable retail investors to leverage their positions, potentially amplifying their returns. However, this leverage also significantly increases their exposure to risk. The possibility of high gains can overshadow the complexities, luring even inexperienced traders into a highly volatile market.

Despite the widespread belief that futures and options are a path to easy money, SEBI’s data indicates that the majority of retail traders end up losing instead of gaining. Many newcomers are drawn by success stories, often ignoring the considerable risks involved.

Lack of Financial Literacy: The Major Culprit

According to SEBI’s report, most individual traders in the F&O segment lack the financial knowledge required to navigate this complex market. More than 75% of traders had an annual income of under ₹5 lakh, suggesting they might not be adequately prepared for the risks.

Many rely on unverified tips from social media or peers, without fully understanding market dynamics, pricing models, or risk management. In fact, a large chunk of these traders continue in the market despite facing losses year after year. Behavioral biases like overconfidence, loss aversion, and herd mentality also cloud their judgment, leading to poor decisions.

Key Insight: Retail investors often jump into F&O trading without proper preparation, and behavioral biases further contribute to their losses.

High Transaction Costs: Death by a Thousand Cuts

Another significant factor behind retail investors’ losses is the high transaction costs involved in F&O trading. SEBI’s report reveals that traders spent an average of ₹26,000 per person on transaction costs in FY24 alone. These costs, including brokerage and exchange fees, slowly but steadily erode potential profits. This challenge is particularly pronounced for frequent traders, who may overlook how much these seemingly small charges impact their overall profitability. Moreover, SEBI’s report found that over ₹50,000 crores were collectively spent on transaction costs during FY22 to FY24. As these costs add up, retail investors find it increasingly difficult to turn a profit.

The Dangers of Leverage: Amplifying Losses

The concept of leverage is what makes F&O trading attractive to retail investors—small capital, big exposure. However, this same leverage is a double-edged sword. Even a minor adverse movement in the underlying asset can result in enormous losses. SEBI’s report confirms this trend, showing that 93% of traders incur losses mainly due to overexposure to risk without fully understanding the implications.

Leverage works by allowing traders to control larger positions with minimal investment, but the higher the leverage, the higher the stakes. Unfortunately, many retail investors fail to grasp this risk and overextend themselves, leading to their financial downfall.

Behavioral Biases and Their Consequences

Behavioral biases significantly contribute to the losses in F&O trading. Overconfidence leads traders to believe they can “time” the market better than others, while loss aversion prompts them to hold onto failing trades in the hope of a rebound. Herd mentality drives many to follow market trends without conducting their own analysis. These biases cloud judgment, making it harder for retail investors to make rational, well-informed decisions.

For instance, the SEBI study highlighted that despite consecutive losses, 75% of traders continued to participate in F&O trading, suggesting a lack of rational reflection on their own past performance.

Read more about Behavioral Biases – Flipping Behavior in IPO Markets: Insights and Implications

Why the Trend Persists Despite the High Loss Rates

Several factors explain why retail investors continue to flock to F&O trading, even though a vast majority face losses:

Misleading Success Stories: The media often highlights the rare success stories of massive profits in F&O trading, fostering a false sense of security among retail investors.
Lack of Financial Education: Many investors are ill-equipped to understand the complexities of derivatives trading. SEBI’s findings point to a persistent gap in financial literacy, particularly among young investors and those from smaller cities (B30 cities), who made up over 72% of the F&O trader base in FY24.
Psychological Thrill: The excitement of potential quick profits can cloud judgment. The emotional highs of winning a trade can often push investors into taking more risks than they should.
Inadequate Regulatory Measures: Although SEBI has implemented regulations to curb risks, more robust measures, such as mandatory educational programs and stricter controls on leverage, are still needed.

Conclusion: How Can Retail Investors Protect Themselves?

The SEBI report is a stark reminder of the dangers of equity derivatives for uninformed retail investors. To avoid becoming part of the 93%, it is crucial for retail investors to improve their financial literacy, particularly concerning market dynamics and risk management. Regulatory bodies can play a significant role by enforcing stricter rules and requiring education before participation in F&O trading.

In the end, while futures and options may seem like a fast route to riches, the reality for most retail investors is far bleaker. Awareness, caution, and a solid understanding of the risks involved are key to ensuring a healthier, more balanced trading environment.

By bringing these concerns to light, this article aims to inform and caution retail investors about the pitfalls of F&O trading, helping them make smarter, more informed decisions.