Futures For You - December 2007

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

BE A MANAGER
I'm just getting started in the commodity futures markets. In your opinion, what is the most important thing to focus on as I begin trading?
Like holiday shoppers looking for that perfect gift, most beginning investors long for the one-size-fits-all answer to this question. After all, from searching for a good trading opportunity to navigating the intricacies of technical analysis to trying to find the right broker, new futures traders have a lot on their minds. It would certainly be helpful to have one overriding aspect of the process on which to focus.
Throughout the year in this column, we've covered important factors to keep in mind as a new trader, from setting stops to formulating a trading plan. Although these topics are important, there is, in fact, one particular aspect of investing in these markets that should rise to the top of the list for most new traders -- money management. Thanks to the huge leverage involved with trading futures, money management can make or break a new futures trader. After all, the ability to endure losses and stay in the market is really the greatest measure of success for new traders.
And surviving in the futures markets absolutely requires sound money management. New traders -- even those who start out hot -- will eventually find that at least some trades are not going to go their way. Without good money management principles to accommodate those losing trades, there's a high likelihood that early profits won't last, and he'll be out of the market before he knows it. Conversely, a novice trader who uses good, conservative money management techniques will be able to withstand some adversity and live to trade another day.
In fact, some successful futures traders wind up with more losing trades than winning ones at the end of the year. There's only one way to derive trading success from that type of formula -- smart money management. Successful traders set tight stops to get out of losing positions quickly while letting winners ride out the trend. At the end of the day, good money management can allow a few big winning trades to more than offset the numerous small losers.
Of course, "good money management" is a relative principle -- even within this dictum, there is no one right answer. Take, for instance, a trader with equity of $4,000 in his account who suddenly finds himself up $3,000 on a corn trade. In this case, he may want to get out with this profit intact to build up his account and better prepare himself for the eventual drawdowns to come.
On the other hand, a trader with a $30,000 account with that same $3,000 winning corn trade may want to let the winner ride a little longer, since taking the profit would not have nearly the impact on his account that it would the smaller-capitalized trader. The temptation for anyone might be to ride the winning trade, but for the first trader, sound money management suggests he should think about getting out now to be better prepared for the future.
Of course, there's nothing wrong with starting out with, or even maintaining, a smaller-capitalized futures trading account. But the smaller the account, the more crucial good money management becomes. So for beginning futures traders, survival should be top priority. Here are five basic money management guidelines you may want to keep in mind:
Commitment: As a rule, smaller-capitalized traders should not commit more than a third of their trading capital to any one trade, while medium- and larger-capitalized traders should not commit more than 10% of capital to one trade. In other words, the larger the trading account, the smaller the commitment should be to one trade. In fact, many observers would suggest that larger trading accounts should not commit more than 3%-5% of capital to one trade.
Alternatives: Smaller-capitalized traders, by necessity, have to commit a larger percentage of capital to one trade. However, these traders may want to buy options to help limit their risk to the price paid for the option, or perhaps trade minisized -- rather than standard -- futures contracts.
Worthwhile? The risk-reward ratio for a futures trade should be at least 3-to-1. If your risk of loss is $1,000, the profit potential should be at least $3,000. If a proposed trade cannot meet this watermark, it might not be worth pursuing.
Stops: Tight protective stops can help cut losses short and let winners ride the trend.
Let go: Never add to a losing position. Exit the trade, preserve your capital, and start looking for the next trading opportunity.

ASK DAN O'NEIL AT THE S&C MESSAGE-BOARDS!
1. Go to: message-boards.traders.com
2. Log in/Register. If you're not a member, you'll need to register. If you're already a member of message-boards.traders.com, all you need to do is log in!
3. Click on Dan O'Neil.
4. Click on "post message" link or button at the bottom. A form for your question should be displayed. If not, scroll to the bottom of the page to locate the form. And that's it!

Originally published in the December 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
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