Futures For You
| INSIDE THE FUTURES
WORLD
Want to learn how the futures markets really work? Dan O'Neil, a principal at online futures and forex broker Xpresstrade (www.xpresstrade.com), responds to your questions about today's futures markets. To submit a question, post your question to our website at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. |
Dan O'Neil |
DON'T FAIL TO PLAN
I'm thinking about getting into the futures markets because it seems so much more fast-paced and exciting than stocks. But a friend of mine who invests in commodities told me that emotion can be a trader's worst enemy in these markets. How can I avoid getting caught up in the emotions of trading?
Your friend is right. Investing in futures is a thrilling thing to do -- the prospect of riding a bull market to a handsome profit can be exciting. And given the liquidity and constant movement of these markets, the action and emotion is a draw. However, experiencing that emotion and trading on it should be two separate things. It comes down to trading with your head or trading with your heart, and trading with the latter may mean you won't be trading long.
Most long-term traders who succeed in the futures markets have removed emotion from the decision-making process by sticking to a trading plan. Many traders who are already negotiating the markets without a defined plan in place find it difficult to set aside the time and energy to create one midstream; this is a common but unfortunate situation. After all, if you were living in a house built on a shoddy foundation, would you be thankful for every day it didn't collapse and hope that your luck continued, or would you go about finding a way to get things on solid ground?
For new investors just getting into futures, this should be elementary; establishing a trading plan should be a forgone step in the process of doing research and educating yourself about the markets. If you wade into these markets without a plan, you'll be hard-pressed to find the time or energy to create one once you get going.
Risk tolerance is one of the defining characteristics to examine when an investment in futures is being considered, but the ability to control emotion is just as important. The markets are inherently emotional, often taking participants on a roller-coaster ride of huge price swings and substantial volatility. And while even the best trading plan can never completely protect an investor from occasional losses when things don't go as expected, a solid plan can help limit those losses and, just as important, prevent the trader from prematurely exiting a winning position. A philosophy based on emotion, however, will cause nervous newcomers to hit the panic button when the market moves against his or her position, and sell off potentially big wins before they've had a chance to reach their fruitful conclusions.
So what's involved in formulating a trading plan? Because individual characteristics vary among investors, it stands to reason there is no "right" trading plan. And because circumstances change over time, an investor shouldn't necessarily think the plan drafted today will fit forever. Still, any plan, however incomplete or sketchy, beats the alternative.
Like any other financial blueprint, a futures trading plan begins with an assessment of risk capital, risk tolerance, and goals. As you consider how this plan will serve as a guide for your day-to-day trading, you'll also want to consider specific factors such as the markets you plan to trade, how you will monitor your trading activity, what type of analysis you plan to employ (technical, fundamental, a combination thereof), parameters for acceptable gains and losses, and measures you'll use to limit losses (say, stops).
This is all a fair amount of work. Ideally, however, a well-constructed trading plan will serve as a road map as you begin trading, helping you establish a routine and thereby avoid making hasty and ill-advised decisions in the heat of trading. It's fine to enjoy the emotional nature of the futures markets -- in fact, it's part of the fun -- but don't let those emotions control your trading. Put together your trading plan and stick to it. A good plan will keep you in the markets longer, and that's a great way to maintain the best emotion of all -- happiness.
CAST A WIDER NET
My financial advisor does a good job of helping me keep my investments diversified, but he never mentions adding commodities to the mix. Is there a reason not to add futures to my portfolio?
Diversification should be familiar to every investor. The adage about not putting all your eggs in one basket is as trite as it is true. Spreading assets among different investment classes and vehicles is a proven way to minimize risk, since certain assets tend to rise as others fall and vice versa. Still, while most investors agree that diversification is a good idea, fewer can lay claim to a truly diversified portfolio.
Often the problem lies in thinking that stocks and bonds are the only investments available. Sure, it's a good idea to spread money among the stocks in several different industries and sectors, and sprinkle in healthy doses of bonds or real estate vehicles to make things more complete, but limiting oneself to these investments alone won't provide the breadth of investment diversity that most people hope to achieve.
However, bringing commodities into the mix can open up a full range of possibilities, and spread risk further than investing in stocks and bonds alone. The futures markets provide opportunities for delving into areas as diverse as energies, metals, grains, and currencies, among others. This allows investors to participate in markets often negatively correlated with some assets in their current investment mix, meaning that a lull in one area may be offset by a spike in another.
Originally published in the March 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
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