To become a successful futures or stock market trader, one not only has to be savvy at chart forecasting and/or fundamental analysis, he also has to be a good money manager. This is especially true for the futures trader, given the high leverage at play.
Over the years, I have listened to the best traders in the business talk about what makes them succeed in this difficult arena, and nearly every one emphasizes the importance of sound money management. Just last fall, I attended a TAG (Technical Analysis Group) trader's conference in Las Vegas. One of the featured speakers stressed that becoming a successful futures trader should be more an act of survival in the early going than scoring winning trades.
Surviving in the futures market absolutely requires practicing sound money management. Even a rookie trader who starts out with a hot hand will eventually find that at least some trades are not going to go his way. And if he has not employed good money management principles on those losing trades, he will likely have squandered his trading profits and his entire trading account.
Conversely, the novice trader who uses good, conservative money management techniques will be able to withstand some losses and be able to trade another day. The ability to take a loss and trade another day is the key to survival--and ultimate success-- in the futures trading arena.
Here's an important point to consider, regarding money management and successful futures trading: Most successful futures traders will tell you that during the span of a year they have more losing trades than winning trades. Then why are they successful? Because of good money management. Successful traders set tight stops to get out of losing positions quickly; and they let the winners ride out the trend. On the balance sheet, a few big winning trades will more than offset the more numerous small losers. Good money management allows for that to happen.
"Good money management" is a relative principle. A good money- management practice for one trader might not be a good money- management practice for another. Here's a real-life example: I had a fellow email me this week, saying he was up $3,000 in a sugar trade, and that his total trading account was $4,000. Although I don't provide specific trading advice, I told the trader that if he has only a $4,000 trading account and has racked up 3 grand in profits on one trade, he ought to think about building up his account so that he can withstand those drawdowns and losers that will eventually occur.
On the other hand, if a trader with a $30,000 account had a $3,000 winning sugar trade, he may want to let the winner ride a little longer, as pocketing the profit would not nearly double his trading account, as it would the smaller-capitalized trader.
In other words, don't be a greedy trader. There's an old trading adage that says there is room for bulls and bears in the marketplace, but pigs get slaughtered.
Let me emphasize here there is nothing wrong with starting out with, or keeping, a smaller-capitalized futures trading account. But I strongly suggest that those smaller accounts use the very strictest of money management.
There are dozens of good futures and stock trading books available, and most spend at least an entire chapter on money management. Drop me an email if you want some ideas on books to read.
Here are just a few very general money management guidelines:
--For smaller-capitalized traders, don't commit more than half of your trading capital to one trade. For medium- and larger-capitalized traders, you should not commit more than 10% or 15% of your capital to one trade. Smaller-capitalized traders may also want to trade options (buying them, not selling them), as your risk is limited to the price you pay for the option. Or, smaller-capitalized traders may want to trade on the Mid-American Exchange, a division of the Chicago Board of Trade that has smaller futures contract sizes.
--Use tight protective stops in all your trades. Cut your losses short and let the winners ride the trend.
--Never, never, never add to a losing position.
--Your risk-reward ratio in a futures trade should be at least three to one. In other words, if your risk of loss is $1,000, your profit potential should be at least $3,000.
I can't stress enough that survival in the futures trading arena (especially for beginners) should be your top priority.
That's it for this week. Again, drop me an email with your questions or comments. Until next week…
Jim Wyckoff (jwyckoff@futuresource.com)
