In this article, I’ll discuss six risk management methods investors may not normally consider but should be actively practicing while trading in the futures market. Properly managing one’s risk may not reap bountiful profits in and of itself, but in my experience, it ensures that your short-term trading doesn’t result in short-term involvement in the markets.
- Know the size of your trading account.
- Understand how leverage can affect it.
- Ensure you are appropriately margined given your risk tolerance.
Utilize your futures broker.
Talk straight with your futures broker and discuss you’re your goals for risk management upfront. Ask your broker what amount of leverage is appropriate for you given your risk tolerance and account size. Discuss your trading style and ideas for minimizing risk through relevant trading strategies.
By talking candidly and developing an open, trusting relationship, you can ensure your broker has a clear understanding of your needs and expectations in regard to risk. This will allow your broker to better serve as your trading advocate. Having this additional set of eyes – no less a professional’s eyes – watching your account can go a long way to helping you manage risk and achieve your futures trading goals.
Address risk upfront.
Managing risk should begin before a trade is even made. Questions should be abundant prior to entering the market. On the contrary, there should be very few questions once a position is established. By addressing risk early in the trading stage, you leave nothing to chance when emotions run high.
Understand the markets you are trading.
It is important to realize that some markets are not for everyone and being involved in highly volatile markets requires proper capitalization and a definite discipline. Understand the effect of adverse price action and how it would translate to your account balance. This fundamental understanding needs to be addressed before trading in a particular market.
No matter where you get a trading idea, whether it is speaking to your futures broker or forming an opinion on your own, it is important to understand the market being considered. Understanding why the market is where it is, what the market’s typical trading range is and what important events are on the horizon (i.e. upcoming report numbers, news stories or any other pertinent fundamental/technical information) could provide crucial insight in regard to the timing of certain trades and the amount of margin that may be appropriate given your objective. Again, utilize your futures broker to assist you in this area.
Trade within your comfort zone.
Simply put, do not overtrade. It is not necessary to take full advantage of reduced margins in the futures market. Having multiple positions on in the same market should be a trading style reserved for traders with enough capital in their accounts to back such a stance. In my opinion, keeping your margin to equity ratio at or below 40% is a good rule of thumb for maintaining proper leverage. Be sure to consciously remember that as much as profits appreciate with multiple contracts on, the losses accrue on the same scale.
Refrain from too much diversification.
While diversification is generally a good thing, it is also important to realize that you can be too “diversified”. Having positions on in many different market sectors can be detrimental if the entire market is experiencing a broad spectrum bullish or bearish tilt, as you could be on the wrong side of many markets all at the same time.
Success is not always measured by profit size alone. It is also highly dependant on proper money management. Capital preservation and proper risk management is the key to remaining present in the markets.
By no means are the ideas I have put before you the only things to be considered when managing risk. But I will say, in all the years I have serviced clients and their accounts, these ideas are some of the least considered, yet most valuable.