Commodity Futures Trading for Beginners

By Bruce Babcock

Elements of a Successful Trading Plan--Manage Risk

The final cardinal principle of trading overlays all the rest. It is Manage Risk. This is as crucial as the others because it is by managing risk that you limit losses and preserve your capital.

The most important element of managing risk is keeping losses small, which is already part of your trading plan. Never give in to fear or hope when it comes to keeping losses small. Preventing large individual losses is one of the easiest things a trader can do to maximize his chance of long-term success.

Another element of risk is the market you trade. Some markets are more volatile and more risky than others. Some markets are comparatively tame. If you have a small account, don't trade big-money, wild-swinging contracts like the S&P 500 stock index. Don't be above using the smaller-sized Mid-America contracts to keep risk in proportion to your capital. Don't feel you have to trade any market that might make a move. Emphasize risk control over achieving big profits.

The biggest risks to commodity traders come from surprise events that move the markets too quickly to exit at their pre-determined give-up point. While you can never eliminate these risks entirely, you can guard against them by advance planning. Pay attention to the risk of surprise events such as crop reports, freezes, floods, currency interventions and wars. Most of the time there is some manifestation of the potential. Don't overtrade in markets where these kinds of events are possible.

Trade in correct proportion to your capital. Have realistic expectations. Don't overtrade your account. One of the most pernicious roadblocks to success is greed. Commodity trading is attractive precisely because it is possible to make big money in a short period of time. Paradoxically, the more you try to fulfill that expectation, the less likely you are to achieve anything.

The pervasive hype that permeates the industry leads people to believe that they can achieve spectacular returns if only they try hard enough. However, risk is always commensurate with reward. The bigger the return you pursue, the bigger the risk you must take. Even assuming you are using a method that gives you a statistical edge, which almost nobody is, you must still suffer through agonizing equity drawdowns on your way to eventual success.

It is better to shoot for smaller returns to begin with until you get the hang of staying with your system through the tough periods that everyone encounters. Professional money managers are generally satisfied with consistent annual returns of twenty percent. If talented professionals should be satisfied with that, what should you be satisfied with? Surprisingly, disciplined individuals can do better. It is realistic for a good mechanical system diversified in the best markets to expect annual returns in the twenty-five to fifty percent range.

One last thing about creating a trading plan. Don't be enticed into trading options as a less risky alternative to futures. While the dollar risk of buying puts and calls may appear lower and more certain, the probability of long-term success is remote.

Experienced professional traders, such as Larry Williams, agree: "Options are a very difficult game because you have to do two things: You have to beat the market and beat the clock. Perhaps some sophisticated people can trade options. I've been trading stocks and commodities successfully for over thirty years, but I don't trade options because it's too tough."

The best way to trade options is to sell them to small speculators. That's what options professionals do. However, selling options has more risk and is more difficult than trading futures. Unless you are well-capitalized and committed to a full-time career as a professional options player, stick to futures.

Although the commodity markets appear complex from the outside, making money trading is quite simple. You use an historically proven plan that trades with the trend, cuts losses short and lets profits run. You trade your system in a carefully selected group of markets. You start with sufficient capital and pay close attention to managing risk. Richard Dennis made his $200 million following precisely this kind of trading approach.

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