Commodity Futures and Options Trading – Money Management, Risk and Trading Logic, PART 5
Perhaps the most important aspect to master in trading is survival. It’s number one. Without surviving the bad times, we left, hopeless. Money management and risk may seem like boring topics, but read on to see just how exciting they can be once you learn the practical reasons and logic behind using them. You may never trade the same way again!
If you trade with 70% accuracy, you can risk maybe 10% on every commodity trade and survive bad runs. But, even a 70% accurate commodity futures trader will have times when they get it wrong 5-6 times in a row and more. The best traders risk less than 5% on each trade. That’s what it means to have a big bankroll. Not to take big positions, but to survive the bad times and be able to trade another day.
Commodity futures pros don’t have the luxury of blowing their accounts like someone who has a day job and trades for a hobby. It’s like playing poker and having the advantage of having the most chips at the table. Probability smiles on those who can hang on the longest to let the odds swing. Those who are underfunded, so for a short time (risk a lot on each trade) must be “lucky” to catch a run before their tokens disappear. This is why we need a method that attempts to identify “high probability, low risk” trades. Remember this phrase: “high probability, low risk trades”
If you have less money in your commodities account than you want, you can also get this “deep pockets” advantage by reducing your trade size. Most commodity futures and options traders could easily cut their normal position size in half and instantly become better traders. Reduced pressure and survivability are just two of the many reasons to trade smaller.
Another point on the losses. Whether you use a mental or real stop loss order, that exit point should be determined based on the specific market setup or conditions and not based on how much money you think you need to risk that day. You should start by deciding how far the market needs to go to undo your setup and get you wrong.
If price has to go far to prove you wrong, then that’s not a low risk setup, is it? Once you have determined this distance, then and only then can you decide how many future contracts or options to buy. If your money management metrics say to risk $1,000 and the distance to prove you wrong is $500 per contract, that means you can only hold two futures contracts. That’s it.
Many commodity futures traders do this backwards by saying they want to buy ten futures – now where do they stop to risk just $1,000? The stop will probably be too close and it will be like giving money. It’s just another form of over-exchange. The commodity market doesn’t care how much money you want to risk. The only concern for you is when you are wrong and that is when you want to throw in the towel for your predetermined loss.
With a small position, you can let the market fight for your money by going a long way, breaking stubborn support or resistance, or not cutting anywhere for a while. Whatever you do, don’t load a commodity position with more than your normal amount of risk, then place a close stop and think, “this time it’s different.”
Play the game for the long haul with every trade executed as perfectly as possible. The fiercest competition is trying to get your money’s worth by doing it right every time. Don’t make it easy for them. Stay in the game, trade small, and execute your plan perfectly every time. This will give you an edge over the vast audience. Public speculators are generally bad traders with little discipline and plans. Be better than them and you have a fighting chance. Don’t worry about superstars. There will be times when you eat their lunches as well. No one wins all the time.
I focus a lot on the loss strategy because if you can cut them down drastically, the profits will take care of themselves. Realize that losses are part of the commodity futures and options game and that there is no such thing as a perfect trading system. Demanding business perfection from yourself is futile and a sure path to failure. To make money, you don’t need to be the best trader in the world – just better than most!
There is substantial risk of loss on futures and options and may not be suitable for all types of investors. Only risk capital should be used.