Risk Management: Use it or Lose it

Risk management begins with each new trade. Futures traders that fail to use it will eventually lose their money.

Every successful commodity trader knows that the key to trading is in managing their risks and to avoid overtrading. In order to control your risk, you must first know what your risks are.

In this article you will learn:

1. to determine what your risks are
2. to measure your risk
3. to avoid overtrading
4. how our strategies manage your exposure through risk management

Prior to taking any new trade, you must know where you will exit (or where your stop loss is) and how much equity is in your account. By obtaining the difference between your entry and stop loss point and converting it into dollars, you can determine how much capital to risk per trade.

Successful system traders risk as little of their money, as possible. Larger capitalized futures traders rarely risk more than 1% per trade. Smaller size traders (those with accounts under 250k) don’t have this luxury; their risk will usually be around 2 - 4% of their account equity.

Risking more money per trade makes risk management more crucial for the smaller sized trader. If you’re trading an account with 80k and risking 3%, you’ll only trade when the initial trade risk is $2400 or less. If the risk is greater than $2400, you’ll simply bypass the trade.

Amateur futures traders often fight this idea and fear if they pass on trades, they may miss the big one. The reality, however, is that your account equity dictates your limits. Your only other option is to trade with more money. Successful commodity traders understand this and protect themselves from being hurt by any one trade.

Risking 3% per trade may seem very timid to you. However, we assure you it is not. A standard commodity trading system or strategy in the 100k account range will trade approximately 20 -25 markets and take 4-5 trades per market per year. This will result in about 100 trades per year. If you risked 3% per trade, at the end of the year you would have risked about 300% of your equity (or close to 300k).

The required margin for futures is only approximately 7% of the underlying contract value. Margin is calculated by the exchanges and it is a measure of volatility. Many futures trading systems and strategies use similar methods for calculating stop loss orders.

For simplicity’s sake, let's assume your initial risk per trade is equivalent to the initial margin rate. In the example above, in which you risked 300k throughout the year, the underlying collateralized value of the contracts you traded would be about 4.2 million dollars.

This is why you can make a lot of money trading commodity futures; it is also why if you do not control your risk, you can lose a lot as well.

It is estimated that 90% of all accounts trading in the commodity futures markets lose money. Being undercapitalized is the main reason for this. Not controlling risk is the next.

The bottom line… risk management is essential to becoming and remaining successful in futures trading. Now, you have an understanding of how the professionals do it.

Taking small risks and not overtrading is the key to successful trading. This includes not risking too much of your capital on a single trade and keeping your number of yearly trades to a minimum.

Before you trade any strategy or system, these simple calculations can determine what you will really be risking throughout the year.

Equity Risked Per Year = Average Losing Trade x Average Number of Trades per year

Fully Collateralized Contract Value per Year = Equity Risked Per Year / Estimated Margin Requirement (0.07 %)

Don’t ever forget… risk management is the key to successful trading. No other trading strategies or systems manage risks better than Commodity Trading Solutions’ strategies.

The Commodity Index Strategy has an average trade risk of only $1,164 and trades an average of only 20 times per year. That is risking only $23,280 of your account per year. The fully collateralized value of the contract is only 333k, as compared to 4.2 million in the previous example.

The Commodity Trading Strategy has an average trade risk of only $783 and trades an average of only 52 times per year. This equates to risking $40,716 and having a fully collateralized annual contract value of about 582k, a superb example of using risk management to avoid overtrading.

Commodity Futures Trading Commission Required Risk Disclosure
Futures and options trading involve substantial risk. The valuation of futures and options may fluctuate, and as a result, clients may lose more than their original investment. In no event should the content of this website be construed as an express or an implied promise, guarantee or implication by or from Commodity Trading Solutions LLC that you will profit or that losses can or will be limited in any manner whatsoever. Past performance is not necessarily indicative of future results. Information provided on this website is intended solely for informative purposes and is obtained from sources believed to be reliable. Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted.