Possibly the most important aspect to get right in trading is survival. This is number one. Without surviving the bad times we are gone, with no hope. Money management and risk may sound like boring subjects, but read on to see how exciting they can be once you learn the concrete reasons and logic for their use. You may never trade the same way again!
If you are trading at 70% accuracy, you can risk perhaps 10% on each commodity trade and survive the bad runs. But, even a 70% accurate commodity futures trader will have times when he is wrong 5-6 times in a row and more. The best traders risk less than 5% on each trade. That’s what having a big bankroll is all about. Not to carry large positions, but to survive the bad times and be able to trade another day.
Commodity futures pros do not have the luxury of blowing out their accounts like someone who has a day job and trades for a hobby. It’s like playing poker and having the advantage of the most chips at the table. Probability smiles on those who can hang in there the longest to let the odds swing their way. Those who are under-capitalized, thus in for a short spell, (risk a lot on each trade) have to be “lucky” to catch a run before their chips disappear. That’s why we need to have a method that attempts to identify, “high probability, low risk” trades. Remember this phrase: “high probability, low risk trades”
If you have less commodity account money to trade with than you desire, you can also gain this “deep pockets” edge by reducing your trading size. Most commodity futures and options traders could easily reduce their normal position size by one-half and instantly become better traders. Reduced pressure and survivability are only two of many reasons to trade smaller.
One more point about losses. Whether you use a mental or actual stop loss order, this exit point must be determined based on the specific market set up or conditions and not based on how much money you feel you should risk that day. You should start by deciding how far the market needs to move to negate your set up to make you wrong.
If price needs to go a long way to make you wrong, then this is not a low risk set up, now is it? Once you determine this distance, then and only then can you decide on how many future contracts or options to buy. If your money management parameters say to risk $1000, and the distance to prove you wrong is $500 a contract, then that means you can hold only two futures contracts. That’s it.
Many commodity futures traders do this backwards by saying they want to buy ten futures contracts – now where do they put their stop to risk only $1000? The stop will probably be too close and it will be like giving money away. It’s just another form of over-trading. The commodity market doesn’t care how much money you want to risk. The only concern for you is at what point are you wrong and that’s the point you want to throw in the towel for your predetermined loss.
With a small position you can let the market fight to get your money by traveling a long way, breaking through stubborn support or resistance, or chopping nowhere for a period of time. Whatever you do, don’t load up on a commodity position with more than your normal risk amount and then place a close stop and think, “this time is different.”
Play the game for the long run with every trade executed as perfectly as you can. The keenest competition out there is trying to get your money by doing things correctly every time. Don’t make it easy for them. Stay in the game, trade small, and execute your plan flawlessly every time. This will give you an edge over the vast public. Public speculators are generally poor traders with little discipline and plans. Be better than them and you have a chance of coming out ahead. Don’t worry about the superstars. There will be times when you eat their lunches too. Nobody wins all the time.
I focus much on loss strategy because if you can greatly reduce them, then the profits will take care of themselves. Realize that losses are part of the commodity futures and options game and no perfect trading system exists. Demanding trading perfection of yourself is futile and a sure road to failure. To make money, you don’t have to be the best trader in the world – just better than most!
There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.